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PaineWebber Strategic Income Fund
1285 AVENUE OF THE AMERICAS, NEW YORK, NEW YORK 10019
PROSPECTUS -- JUNE 3, 1996
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PAINEWEBBER STRATEGIC INCOME FUND is a professionally
managed mutual fund seeking a high level of current income
and, secondarily, capital appreciation by strategically
allocating its investment portfolio among sectors of the
U.S. and foreign fixed income securities markets.
The Fund is a series of PaineWebber Securities Trust
('Trust'). This Prospectus concisely sets forth
information about the Fund a prospective investor should
know before investing. Please retain this Prospectus for
future reference.
THE FUND MAY INVEST PREDOMINANTLY IN LOWER RATED BONDS,
COMMONLY REFERRED TO AS 'JUNK BONDS.' BONDS OF THIS TYPE
ARE CONSIDERED TO BE SPECULATIVE WITH RESPECT TO THE
PAYMENT OF INTEREST AND RETURN OF PRINCIPAL. PURCHASERS
SHOULD CAREFULLY ASSESS THE RISKS ASSOCIATED WITH AN
INVESTMENT IN THIS FUND.
A Statement of Additional Information dated June 3, 1996
(which is incorporated by reference herein), has been
filed with the Securities and Exchange Commission. The
Statement of Additional Information can be obtained
without charge, and further inquiries can be made, by
contacting the Fund, your PaineWebber investment executive
or PaineWebber's correspondent firms or by calling
toll-free 1-800-647-1568.
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An investment in PaineWebber Strategic Income Fund offers
the following advantages:
<TABLE>
<S> <C>
/ / PROFESSIONAL MANAGEMENT / / AUTOMATIC INVESTMENT PLAN
/ / DIVIDEND AND CAPITAL GAIN / / SYSTEMATIC WITHDRAWAL PLAN
REINVESTMENT / / EXCHANGE PRIVILEGES
/ / FLEXIBLE PRICING(Service Mark) / / SUITABLE FOR RETIREMENT PLANS
/ / LOW MINIMUM INVESTMENT
</TABLE>
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
NOR HAS ANY SUCH COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
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Prospectus Page 1
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PaineWebber Strategic Income Fund
TABLE OF CONTENTS
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<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary................................ 3
Financial Highlights.............................. 7
Flexible Pricing System........................... 8
Investment Objectives and Policies................ 9
Purchases......................................... 19
Exchanges......................................... 23
Redemptions....................................... 23
Conversion of Class B Shares...................... 24
Other Services and Information.................... 25
Dividends and Taxes............................... 26
Valuation of Shares............................... 27
Management........................................ 27
Performance Information........................... 29
General Information............................... 30
Appendix A........................................ 31
Appendix B........................................ 34
Appendix C........................................ 37
</TABLE>
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Prospectus Page 2
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PaineWebber Strategic Income Fund
PROSPECTUS SUMMARY
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See the body of this Prospectus for more information on the topics discussed in
this summary.
<TABLE>
<S> <C>
The Fund: PaineWebber Strategic Income Fund ('Fund') is a non-diversified series of an
open-end management investment company.
Investment Objectives and Policies: The Fund's primary investment objective is to achieve a high level of current
income. As a secondary objective, the Fund seeks capital appreciation. The
Fund seeks to achieve its investment objectives by investing in a portfolio of
fixed income securities (including debt instruments the payment on which may
be fixed, variable or floating and also zero coupon securities that pay no
interest until maturity) that is strategically allocated among the following
investment sectors: U.S. government and investment grade securities, U.S. high
yield, high risk securities, and foreign and emerging market securities. A
portion of the Fund's assets normally will be invested in each of these
investment sectors, but the Fund has the flexibility at any time to invest all
or substantially all of its assets in any one of these sectors.
Total Net Assets: $66.3 million at April 30, 1996.
Investment Adviser: Mitchell Hutchins Asset Management Inc. ('Mitchell Hutchins'), an asset
management subsidiary of PaineWebber Incorporated ('PaineWebber'), manages
over $43.9 billion in assets. See 'Management.'
Purchases: Shares of beneficial interest are available exclusively through PaineWebber
and its correspondent firms for investors who are clients of PaineWebber or
those firms ('PaineWebber clients') and, for other investors, through PFPC
Inc., the Fund's transfer agent ('Transfer Agent').
Flexible Pricing System: Investors may select Class A, Class B or Class C shares, each with a public
offering price that reflects different sales charges and expense levels. See
'Flexible Pricing System,' 'Purchases,' 'Redemptions' and 'Conversion of Class
B Shares.'
Class A Shares Offered at net asset value plus any applicable sales charge (maximum is 4% of
public offering price).
Class B Shares Offered at net asset value (a maximum contingent deferred sales charge of 5%
of redemption proceeds is imposed on certain redemptions made within six years
of date of purchase). Class B shares automatically convert into Class A shares
(which pay lower ongoing expenses) approximately six years after purchase.
Class C Shares Offered at net asset value without an initial sales charge. (For shares
purchased on or after November 10, 1995, a contingent deferred sales charge of
0.75% is imposed on most redemptions made within one year of date of
purchase.) Class C shares pay higher ongoing expenses than Class A shares and
do not convert into another Class.
Exchanges: Shares may be exchanged for shares of the corresponding Class of most
PaineWebber mutual funds.
Redemptions: PaineWebber clients may redeem through PaineWebber; other shareholders must
redeem through the Transfer Agent.
Dividends: Declared and paid monthly; net capital gain is distributed annually. Net
realized gains from foreign currency transactions and net short-term capital
gain, if any, also are distributed at least annually. See 'Dividends and
Taxes.'
Reinvestment: All dividends and other distributions are paid in Fund shares of the same
Class at net asset value unless the shareholder has requested cash.
Minimum Purchase: $1,000 for the first purchase; $100 for subsequent purchases.
</TABLE>
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Prospectus Page 3
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PaineWebber Strategic Income Fund
PROSPECTUS SUMMARY
(CONTINUED)
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<TABLE>
<S> <C> <C>
Other Features:
Class A Automatic investment plan Quantity discounts on initial sales
Shares Systematic withdrawal plan charge
Rights of accumulation 365-day reinstatement privilege
Class B Automatic investment plan Systematic withdrawal plan
Shares
Class C Automatic investment plan Systematic withdrawal plan
Shares
</TABLE>
------------------------
WHO SHOULD INVEST. The Fund enables investors to participate in investment
opportunities in three distinct sectors of the fixed income market: (1) U.S.
government securities and investment grade securities of corporate and other
non-governmental U.S. issuers ('U.S. Government and Investment Grade
Securities'); (2) high yield, high risk securities of U.S. issuers ('U.S. High
Yield Securities'); and (3) government, corporate or other securities of
non-U.S. issuers ('Foreign and Emerging Market Securities').
Each of these sectors generally reacts differently to interest rate changes and
reacts in different ways or at different times to different economic events.
Data from the Lehman Aggregate Bond Index, the Salomon Brothers High Yield
Index, the Merrill Lynch High Yield Index and the Salomon Brothers World
Government Bond Index indicate that these sectors are not closely correlated.
This means that when one sector underperforms the market as a whole, another
sector may perform at roughly the same level as the market, while the third
sector may outperform the market.
The Fund has the flexibility to strategically allocate its assets among these
investment sectors to attempt to realize a high level of current income and,
secondarily, capital appreciation, based upon economic conditions and interest
rate trends both in the United States and around the world.
However, the Fund is designed for investors willing to assume additional risk in
return for the potential for such returns. While the Fund is not intended to
provide a complete or balanced investment program, it can serve as one component
of an investor's long-term program to accumulate assets for retirement, college
tuition or other major goals.
RISK FACTORS. There can be no assurance that the Fund will achieve its
investment objectives. Prospective investors are urged to read 'Investment
Objectives and Policies' for more complete information about risk factors.
The U.S. High Yield Securities and all or a portion of the Foreign and Emerging
Market Securities in which the Fund invests will be rated below investment grade
(BB or Ba/ba or lower) by Standard & Poor's, a division of The McGraw Hill
Companies, Inc. ('S&P'), or Moody's Investors Service, Inc. ('Moody's'), be
comparably rated by another nationally recognized statistical rating
organization ('NRSRO') or, if not rated, will be determined by Mitchell Hutchins
to be of comparable quality to such rated securities. Such securities (commonly
known as 'junk bonds') are subject to greater risks of default or price
fluctuation than investment grade securities and are deemed by S&P and Moody's
to be predominantly speculative. High yield, high risk securities are especially
subject to adverse changes in general economic conditions and in the industries
in which the issuers are engaged, to changes in the financial condition of the
issuers and to price fluctuations in response to changes in interest rates.
Foreign securities, particularly those of issuers located in emerging markets,
involve certain considerations not typically associated with investing in
securities of U.S. companies. These include risks relating to political, social
and economic developments abroad and to the differences between the regulations
to which U.S. and foreign issuers and markets are subject. Individual foreign
economies may differ from the U.S. economy. Investments in sovereign debt of
foreign governments involve special risks. The Fund may invest without limit in
securities denominated in currencies other than the U.S. dollar and may hold
foreign currencies. The value of these investments thus can be adversely
affected by fluctuations in foreign currency values. Some foreign currencies can
be volatile and may be subject to governmental controls or intervention.
As a 'non-diversified' investment company, as defined in the Investment Company
Act of 1940 ('1940 Act'), the Fund may be subject to greater risk with respect
to its portfolio securities than an investment company that is 'diversified,'
because changes in the financial condition or market assessment of a single
issuer may cause greater fluctuations in the total return and price of the
Fund's shares. The Fund's use of options, futures contracts and forward currency
contracts also entails special risks.
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Prospectus Page 4
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PaineWebber Strategic Income Fund
PROSPECTUS SUMMARY
(CONTINUED)
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EXPENSES OF INVESTING IN THE FUND. The following tables are intended to assist
investors in understanding the expenses associated with investing in Class A, B
and C shares of the Fund.
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C
------- ------- -------
<S> <C> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES(1)
Maximum sales charge on purchases of
shares (as a percentage of public
offering price).................... 4% None None
Sales charge on reinvested
dividends.......................... None None None
Exchange fee.......................... $5.00 $5.00 $5.00
Maximum contingent deferred sales
charge (as a percentage of net
asset value at the
time of purchase or redemption,
whichever is less)................. None(2) 5% 0.75%(3)
ANNUAL FUND OPERATING EXPENSES(4) (AS A
PERCENTAGE OF AVERAGE NET ASSETS)
Management fees....................... 0.75% 0.75% 0.75%
12b-1 fees(5)......................... 0.25 1.00 0.75
Other expenses........................ 0.74 0.74 0.74
------- ------- -------
Total operating expenses.............. 1.74% 2.49% 2.24%
------- ------- -------
------- ------- -------
</TABLE>
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(1) Sales charge waivers are available for all shares and reduced sales charge
purchase plans are available for Class A shares. The maximum 5% contingent
deferred sales charge on Class B shares applies to redemptions during the
first year after purchase; the charge generally declines by 1% annually
thereafter, reaching zero after six years. See 'Purchases.'
(2) Purchases of Class A shares of $1 million or more are not subject to an
initial sales charge. However, a contingent deferred sales charge of 1% will
be applied to most redemptions of such shares within one year of purchase.
See 'Purchases.'
(3) A contingent deferred sales charge of 0.75% will be applied to most
redemptions of Class C shares within one year of purchase. See 'Purchases.'
(4) See 'Management' for additional information. The management fee payable to
Mitchell Hutchins is greater than the management fee paid by most funds. All
expenses are those actually incurred for the fiscal year ended January 31,
1996.
(5) 12b-1 fees have two components, as follows:
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C
------- ------- -------
<S> <C> <C> <C>
12b-1 service fees................. 0.25% 0.25% 0.25%
12b-1 distribution fees............ N/A 0.75 0.50
</TABLE>
12b-1 distribution fees are asset-based sales charges. Long-term Class B
and Class C shareholders may pay more in direct and indirect sales charges
(including distribution fees) than the economic equivalent of the maximum
front-end sales charges permitted by the National Association of
Securities Dealers, Inc.
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Prospectus Page 5
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PaineWebber Strategic Income Fund
PROSPECTUS SUMMARY
(CONTINUED)
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EXAMPLE OF EFFECT OF FUND EXPENSES
An investor would directly or indirectly pay the following expenses on a $1,000
investment in the Fund, assuming a 5% annual return:
<TABLE>
<CAPTION>
ONE YEAR THREE YEARS FIVE YEARS TEN YEARS
-------- ----------- ---------- ---------
<S> <C> <C> <C> <C>
Class A Shares(1).................. $ 57 $ 93 $131 $ 237
Class B Shares:
Assuming a complete redemption at
end of period(2)(3)........... $ 75 $ 108 $153 $ 247
Assuming no redemption........... $ 25 $ 78 $133 $ 247
Class C Shares:
Assuming a complete redemption at
end of period(2).............. $ 30 $ 70 $120 $ 257
Assuming no redemption........... $ 23 $ 70 $120 $ 257
</TABLE>
This Example assumes that all dividends and other distributions are reinvested
and that the percentage amounts listed under Annual Fund Operating Expenses
remain the same in the years shown. The above tables and the assumption in the
Example of a 5% annual return are required by regulations of the Securities and
Exchange Commission ('SEC') applicable to all mutual funds; the assumed 5%
annual return is not a prediction of, and does not represent, the projected or
actual performance of any Class of the Fund's shares.
THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE
EXPENSES, AND THE FUND'S ACTUAL EXPENSES MAY BE MORE OR LESS THAN THOSE SHOWN.
The actual expenses attributable to each Class of the Fund's shares will depend
upon, among other things, the level of average net assets and the extent to
which the Fund incurs variable expenses, such as transfer agency costs.
- ------------
(1) Assumes deduction at the time of purchase of the maximum 4% initial sales
charge.
(2) Assumes deduction at the time of redemption of the maximum applicable
contingent deferred sales charge.
(3) Ten-year figures assume conversion of Class B shares to Class A shares at
end of sixth year.
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Prospectus Page 6
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PaineWebber Strategic Income Fund
FINANCIAL HIGHLIGHTS
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The table below provides selected per share data and ratios for one Class A
share, one Class B share and one Class C share for each of the periods shown.
This information is supplemented by the financial statements and accompanying
notes appearing in the Fund's Annual Report to Shareholders for the fiscal year
ended January 31, 1996, which are incorporated by reference into the Statement
of Additional Information. The financial statements and notes, as well as the
financial information in the table below, have been audited by Price Waterhouse
LLP, independent accountants, whose unqualified report thereon is included in
the Annual Report to Shareholders. Further information about the Fund's
performance also is included in the Annual Report to Shareholders, which may be
obtained without charge.
<TABLE>
<CAPTION>
CLASS A CLASS B
----------------------------------------- -----------------------------------------
FOR THE PERIOD FOR THE PERIOD
FOR THE FEBRUARY 7, 1994+ FOR THE FEBRUARY 7, 1994+
YEAR ENDED THROUGH YEAR ENDED THROUGH
JANUARY 31, 1996 JANUARY 31, 1995 JANUARY 31, 1996 JANUARY 31, 1995
---------------- ----------------------- ---------------- -----------------------
<S> <C> <C> <C> <C>
Net asset value, beginning of
period........................... $8.60 $10.00 $8.60 $10.00
------- -------- -------- --------
Net investment income.............. 0.60 0.74 0.54 0.66
Net realized and unrealized gains
(losses) from investment and
foreign currency transactions.... 0.66 (1.49) 0.65 (1.47)
------- -------- -------- --------
Net increase (decrease) from
investment operations............ 1.26 (0.75) 1.19 (0.81)
------- -------- -------- --------
Dividends from net investment
income........................... (0.77) (0.65) (0.71) (0.59)
Distributions from net realized
gains from foreign currency
transactions..................... (0.10) -- (0.10) --
------- -------- -------- --------
Total dividends and other
distributions to shareholders.... (0.87) (0.65) (0.81) (0.59)
------- -------- -------- --------
Net asset value, end of period..... $8.99 $8.60 $8.98 $8.60
------- -------- -------- --------
------- -------- -------- --------
Total investment return(1)......... 15.27% (7.61)% 14.37% (8.22)%
------- -------- -------- --------
------- -------- -------- --------
Ratios/Supplemental Data:
Net assets, end of period
(000's).......................... $9,841 $11,148 $40,653 $40,710
Ratio of expenses to average net
assets........................... 1.74% 1.49%* 2.49% 2.24%*
Ratio of net investment income to
average net assets............... 8.52% 8.06%* 7.77% 7.46%*
Portfolio turnover rate............ 91% 117% 91% 117%
<CAPTION>
CLASS C**
-----------------------------------------
FOR THE PERIOD
FOR THE FEBRUARY 7, 1994+
YEAR ENDED THROUGH
JANUARY 31, 1996 JANUARY 31, 1995
---------------- -----------------------
<S> <C> <C>
Net asset value, beginning of
period........................... $8.60 $10.00
-------- --------
Net investment income.............. 0.55 0.69
Net realized and unrealized gains
(losses) from investment and
foreign currency transactions.... 0.66 (1.48)
-------- --------
Net increase (decrease) from
investment operations............ 1.21 (0.79)
-------- --------
Dividends from net investment
income........................... (0.73) (0.61)
Distributions from net realized
gains from foreign currency
transactions..................... (0.10) --
-------- --------
Total dividends and other
distributions to shareholders.... (0.83) (0.61)
-------- --------
Net asset value, end of period..... $8.98 $8.60
-------- --------
-------- --------
Total investment return(1)......... 14.63% (8.02)%
-------- --------
-------- --------
Ratios/Supplemental Data:
Net assets, end of period
(000's).......................... $19,232 $21,208
Ratio of expenses to average net
assets........................... 2.24% 1.98%*
Ratio of net investment income to
average net assets............... 8.03% 7.62%*
Portfolio turnover rate............ 91% 117%
</TABLE>
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<TABLE>
<S> <C>
+ Commencement of issuance of shares
* Annualized
** Formerly Class D shares
(1) Total investment return is calculated assuming a $1,000 investment on the first day of the period, reinvestment of all
dividends and other distributions at net asset value on the payable dates and a sale at net asset value on the last day
of each period reported. The figures do not include sales charges; results for each Class of shares would be lower if
sales charges were included. Total investment returns for periods of less than one year have not been annualized.
</TABLE>
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Prospectus Page 7
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PaineWebber Strategic Income Fund
FLEXIBLE PRICING SYSTEM
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DIFFERENCES AMONG THE CLASSES
The primary distinctions among the Classes of the Fund's shares lie in their
initial and contingent deferred sales charge structures and in their ongoing
expenses, including asset-based sales charges in the form of distribution fees.
These differences are summarized in the table below. Each Class has distinct
advantages and disadvantages for different investors, and investors may choose
the Class that best suits their circumstances and objectives.
<TABLE>
<CAPTION>
ANNUAL 12B-1 FEES
(AS A % OF AVERAGE DAILY
SALES CHARGE NET ASSETS) OTHER INFORMATION
------------------------------------------------ ---------------------------- ----------------------------
<S> <C> <C> <C>
Class A Maximum initial sales charge of 4% of the public Service fee of 0.25% Initial sales charge waived
offering price or reduced for certain
purchases
Class B Maximum contingent deferred sales charge of 5% Service fee of 0.25%; Shares convert to Class A
upon redemption; declines to zero after six distribution fee of 0.75% shares approximately six
years years after issuance
Class C Contingent deferred sales charge of 0.75% upon Service fee of 0.25%; --
redemption during first year distribution fee of 0.50%
</TABLE>
FACTORS TO CONSIDER IN CHOOSING A
CLASS OF SHARES
In deciding which Class of shares to purchase, investors should consider the
cost of sales charges together with the cost of the ongoing annual expenses
described below, as well as any other relevant facts and circumstances.
SALES CHARGES. Class A shares are sold at net asset value plus an initial sales
charge of up to 4% of the public offering price. Because of this initial sales
charge, not all of a Class A shareholder's purchase price is invested in the
Fund. Class B shares are sold with no initial sales charge, but a contingent
deferred sales charge of up to 5% applies to most redemptions made within six
years of purchase. Class C shareholders pay no initial sales charge, although a
contingent deferred sales charge of 0.75% applies to most redemptions made
within one year after purchase. Thus, the entire amount of a Class B or Class C
shareholder's purchase price is immediately invested in the Fund.
WAIVERS AND REDUCTIONS OF CLASS A SALES CHARGES. Class A share purchases over
$100,000 and Class A share purchases made under the Fund's reduced sales charge
plan may be made at a reduced sales charge. In considering the combined cost of
sales charges and ongoing annual expenses, investors should take into account
any reduced sales charges on Class A shares for which they may be eligible.
The entire initial sales charge on Class A shares is waived for certain eligible
purchasers. Because Class A shares bear lower ongoing annual expenses than Class
B shares or Class C shares, investors eligible for complete waivers should
purchase Class A shares.
ONGOING ANNUAL EXPENSES. Class A, B and C shares pay an annual 12b-1 service
fee of 0.25% of average daily net assets. Class B shares pay an annual 12b-1
distribution fee of 0.75% of average daily net assets. Class C shares pay an
annual 12b-1 distribution fee of 0.50% of average daily net assets. Annual 12b-1
distribution fees are a form of asset-based sales charge. An investor should
consider both ongoing annual expenses and initial or contingent deferred sales
charges in estimating the costs of investing in the respective Classes of Fund
shares over various time periods.
For example, assuming a constant net asset value, the cumulative distribution
fees on the Fund's Class B or Class C shares would approximate the expenses of
the 4% maximum initial sales charge on the Class A shares if the shares were
held for approximately 5 1/2 years in the
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Prospectus Page 8
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PaineWebber Strategic Income Fund
case of the Class B shares and approximately 8 years in the case of the Class C
shares. Class B shares convert to Class A shares (which do not bear the expense
of ongoing distribution fees) approximately six years after purchase. The
cumulative distribution fees on the Fund's Class C shares would approximate the
cumulative distribution fees on the Class B shares if the shares were held for 9
years. Thus, an investor who would be subject to the maximum initial sales
charge on Class A shares and who expects to hold shares of the Fund for less
than 8 years generally should expect to pay the lowest cumulative expenses by
purchasing Class C shares.
The foregoing examples do not reflect, among other variables, the cost or
benefit of bearing sales charges or distribution fees at the time of purchase,
upon redemption or over time, nor can they reflect fluctuations in the net asset
value of Fund shares, which will affect the actual amount of expenses paid.
Expenses borne by Classes may differ slightly because of the allocation of other
Class-specific expenses. The 'Example of Effect of Fund Expenses' under
'Prospectus Summary' shows the cumulative expenses an investor would pay over
time on a hypothetical investment in each Class of Fund shares, assuming an
annual return of 5%.
OTHER INFORMATION
PaineWebber investment executives may receive different levels of compensation
for selling one particular Class of Fund shares rather than another. Investors
should understand that distribution fees and initial and contingent deferred
sales charges all are intended to compensate Mitchell Hutchins for distribution
services.
See 'Purchases,' 'Redemptions' and 'Management' for a more complete description
of the initial and contingent deferred sales charges, service fees and
distribution fees for the three Classes of shares in the Fund. See also
'Conversion of Class B Shares,' 'Dividends and Taxes,' 'Valuation of Shares' and
'General Information' for other differences among the three Classes.
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INVESTMENT OBJECTIVES AND POLICIES
- --------------------------------------------------------------------------------
The Fund's primary investment objective is to achieve a high level of current
income. As a secondary objective, the Fund seeks capital appreciation. The Fund
seeks to achieve its investment objectives by investing in a portfolio of fixed
income securities (including debt instruments the payment on which may be fixed,
variable or floating and also zero coupon securities that pay no interest until
maturity) that is strategically allocated among U.S. Government and Investment
Grade Securities, U.S. High Yield Securities and Foreign and Emerging Market
Securities. Mitchell Hutchins allocates the Fund's assets among these investment
sectors based on its assessment of relative values, currency and interest rate
trends and economic, credit and political conditions. Mitchell Hutchins believes
that the relative investment opportunities and risks presented by securities in
these sectors will vary so that, over time, securities in one or more of the
Fund's three sectors will become undervalued relative to the risks presented.
Accordingly, the relative investment performance of these investment sectors
will change over time, and the best performing sector frequently will change
from year to year.
Mitchell Hutchins seeks to take advantage of these changes in relative
performance by allocating a greater proportion of the Fund's assets in those
investment sectors that it believes are undervalued. A portion of the Fund's
assets normally is invested in each of these investment sectors, which should
reduce the risks associated with investing only in any one sector. However, the
Fund has the flexibility at any time to invest all or substantially all of its
assets in any one sector. If successful, the Fund's strategic allocation should
enable the Fund to achieve a higher level of investment return over time than if
the Fund invested exclusively in any one investment sector or allocated a fixed
proportion of its assets to each investment sector. The Fund is, however, more
dependent on the ability of Mitchell Hutchins to successfully evaluate the
relative values of the Fund's three investment sectors than is the case with a
fund that does not seek to adjust market sector allocations over time. The Fund
is not intended to be a complete investment program and is designed for
investors willing to assume additional risk in return for the potential for high
current income and, secondarily, capital appreciation.
Allocations among the Fund's three investment sectors and investment decisions
with respect to the assets allocated to each sector are made by an investment
management team comprised of Dennis McCauley, who acts as the Fund's allocation
manager, and the Fund's
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Prospectus Page 9
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PaineWebber Strategic Income Fund
sector managers, Nirmal Singh, Craig Varrelman, Thomas J. Libassi and Stuart
Waugh. Determinations as to percentage allocations for each sector are made by
Mr. McCauley, based upon advice from each sector manager as to the market
considerations applicable to his respective sector. Decisions as to investments
within each sector are made by the respective sector managers based on market
outlook, investment research, geographic analysis and forecasts regarding
currencies and interest rates.
There can be no assurance that the Fund will achieve its investment objectives.
The Fund's investment objectives and certain investment limitations as described
in the Statement of Additional Information are fundamental policies that may not
be changed without shareholder approval. All other investment policies may be
changed by the Trust's board of trustees without shareholder approval.
U.S. GOVERNMENT AND INVESTMENT GRADE SECURITIES. The U.S. Government and
Investment Grade Securities in which the Fund may invest include (1) U.S.
Treasury obligations and mortgage-backed and other securities issued or
guaranteed by the U.S. government or its agencies or instrumentalities ('U.S.
government securities') and (2) mortgage-backed and asset-backed securities,
bonds and other fixed and variable rate income securities that are issued by
corporate and other non-governmental U.S. issuers and that at the time of
purchase are rated BBB or higher by S&P or Baa/baa or higher by Moody's, are
comparably rated by another NRSRO or, if not rated, are determined by Mitchell
Hutchins to be comparable to such rated securities. In selecting U.S. Government
and Investment Grade Securities for the Fund's portfolio, Mitchell Hutchins will
consider factors such as the general level of interest rates, changes in the
perceived creditworthiness of the issuers, the prepayment outlook for the
mortgage market and changes in general economic conditions and business
conditions affecting the issuers and their respective industries.
The Fund may invest in U.S. government securities that are backed by the full
faith and credit of the U.S. government, such as U.S. Treasury obligations;
securities that are supported primarily or solely by the creditworthiness of the
government-related issuer, such as securities issued by the Resolution Funding
Corporation, the Student Loan Marketing Association, the Federal Home Loan Banks
and the Tennessee Valley Authority; and securities that are supported primarily
or solely by specific pools of assets and the creditworthiness of a U.S.
government-related issuer, such as U.S. government mortgage-backed securities.
Mortgage-backed securities represent direct or indirect participations in, or
are secured by and payable from, mortgage loans secured by real property. They
include single- and multi-class pass-through securities and collateralized
mortgage obligations. Multi-class pass-through securities and collateralized
mortgage obligations are collectively referred to herein as CMOs. For more
information concerning the types of mortgage-backed securities in which the Fund
may invest, see Appendix B.
Asset-backed securities have structural characteristics similar to
mortgage-backed securities. However, the underlying assets are not first lien
mortgage loans or interests therein, but include assets such as motor vehicle
installment sales contracts, other installment sale contracts, home equity
loans, leases of various types of real and personal property and receivables
from revolving credit (credit card) agreements. Such assets are securitized
through the use of trusts or special purpose corporations. Payments or
distributions of principal and interest on asset-backed securities may be
guaranteed up to certain amounts and for a certain time period by a letter of
credit or a pool insurance policy issued by a financial institution unaffiliated
with the issuer or other credit enhancements may be present.
The yield characteristics of the mortgage- and asset-backed securities in which
the Fund may invest differ from those of traditional debt securities. Among the
major differences are that interest and principal payments are made more
frequently on mortgage- and asset-backed securities, usually monthly, and that
principal may be prepaid at any time because the underlying mortgage loans or
other assets generally may be prepaid at any time. See '--Other Investment
Policies and Risk Factors' herein and 'Investment Policies and Restrictions' in
the Statement of Additional Information.
U.S. HIGH YIELD SECURITIES. The U.S. High Yield Securities in which the Fund
may invest include bonds, debentures, notes, mortgage- and asset-backed
securities, convertible debt and preferred stock that are issued by corporate
and other non-governmental U.S. issuers and that at the time of purchase are
rated BB or lower by S&P or Ba/ba or lower by Moody's, are comparably rated by
another NRSRO or, if not rated, are determined by Mitchell Hutchins to be
comparable to such rated securities. Such securities are commonly referred to as
'junk bonds' and involve a high degree of risk. The U.S. High Yield Securities
in which the Fund may invest may be rated as low as D by S&P or C by Moody's or
be comparable, unrated securities. Such obligations are highly speculative and
may be in default in the payment of interest and the repayment of principal. See
'--Other Investment Policies and Risk Factors.' For further
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information regarding S&P and Moody's ratings, see Appendix A.
In selecting U.S. High Yield Securities for the Fund's portfolio, Mitchell
Hutchins seeks to identify issuers and industries that Mitchell Hutchins
believes are more likely to experience stable or improving financial conditions.
Many corporations are in the process of strengthening, or have recently
improved, their financial positions through cost-cutting, restructuring or
refinancing with lower cost debt. Mitchell Hutchins expects that, at times when
the U.S. economy is improving, these factors and others may lead many issuers to
experience financial improvement and possible credit upgrades. Mitchell Hutchins
seeks to identify these issuers through detailed credit research. Mitchell
Hutchins' analysis may include consideration of general industry trends, the
issuer's experience and managerial strength, changing financial conditions,
borrowing requirements or debt maturity schedules, the issuer's responsiveness
to changes in business conditions and interest rates, and other terms and
conditions. Mitchell Hutchins may also consider relative values based on
anticipated cash flow, interest or dividend coverage, asset coverage and
earnings prospects.
FOREIGN AND EMERGING MARKET SECURITIES. The Foreign and Emerging Market
Securities in which the Fund may invest include (1) Brady Bonds and other debt
securities issued or guaranteed by governments, their agencies,
instrumentalities or political subdivisions located in foreign countries,
including industrialized countries and emerging market countries, or by central
banks located in such countries (collectively, 'Sovereign Debt') and debt
securities issued by multi-national institutions such as the International Bank
for Reconstruction and Development ('World Bank') and the International Monetary
Fund ('IMF'); (2) debt securities and preferred stock issued by corporations,
banks and other business entities located in foreign countries, including
industrialized countries and emerging market countries, or securities
denominated in or indexed to the currencies of foreign countries; and (3)
interests in issuers organized and operated for the purpose of securitizing or
restructuring the investment characteristics of any of the foregoing. The Fund
may invest without limit in securities of issuers located in any country in the
world, including both industrialized and emerging market countries.
Mitchell Hutchins selectively invests the Fund's assets allocated to Foreign and
Emerging Market Securities in securities of issuers in countries where the
combination of income market yields, the price appreciation potential of fixed
income securities and, with respect to non-U.S. dollar-denominated securities,
currency exchange rate movements present opportunities for high current income
and, secondarily, capital appreciation. Determinations as to the foreign markets
in which the Fund invests are based on an evaluation of total debt levels,
currency reserve levels, net exports/imports, overall economic growth, level of
inflation, currency fluctuation, political and social climate and payment
history of the country in which the issuer is located. Particular securities are
selected based upon credit risk analysis of potential issuers, the
characteristics of the security and interest rate sensitivity of the various
issues by a single issuer, analysis of volatility and liquidity of these
particular instruments and the tax implications to the Fund of various
instruments. While the Fund generally is not restricted in the portion of its
assets that may be invested in a single country or region, under normal
conditions, the Fund's assets will be invested in issuers located in at least
three countries. No more than 25% of the Fund's total assets will be invested in
securities issued or guaranteed by any single foreign government.
The Foreign and Emerging Market Securities in which the Fund may invest are not
required to meet any minimum credit rating standard and may not be rated by any
NRSRO. All or a substantial portion of the Fund's investments in Foreign and
Emerging Market Securities may be rated below investment grade or may be unrated
securities with credit characteristics that are comparable to securities that
are rated below investment grade. The Fund may invest without limit in
securities of issuers in emerging market countries and in non-U.S. dollar-
denominated fixed income securities, including securities denominated in the
local currencies of emerging market countries. See '--Other Investment Policies
and Risk Factors' herein and 'Investment Policies and Restrictions' in the
Statement of Additional Information.
OTHER INVESTMENT POLICIES
AND RISK FACTORS
RISKS OF FIXED INCOME SECURITIES. The value of the corporate, government and
other fixed income securities held by the Fund, and thus the net asset value of
the Fund's shares, generally fluctuates with (1) movements in interest rates,
(2) changes in the perceived creditworthiness of the issuers of those securities
and (3) with respect to non-U.S. dollar-denominated securities, changes in the
relative values of the currencies in which the Fund's investments are
denominated with respect to the U.S. dollar. The extent of the fluctuation of
the Fund's net asset value depends on various other factors, such as the average
maturity of the Fund's investments, the extent to which the Fund holds
instruments denominated in foreign currencies and the extent to which the Fund
hedges its interest rate, credit
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and currency exchange rate risks. There are no limitations on the maturities of
the fixed income securities in which the Fund may invest or on the average
maturity of the Fund's portfolio.
RISKS OF HIGH YIELD, HIGH RISK SECURITIES. The U.S. High Yield Securities and
all or a portion of the Foreign and Emerging Market Securities in which the Fund
invests are high yield, high risk securities that are rated below investment
grade or are comparable, unrated securities. Debt securities rated below
investment grade are deemed by S&P and Moody's to be predominantly speculative
with respect to the issuer's capacity to pay interest and repay principal and
may involve major risk exposures to adverse conditions.
The high yield, high risk securities in which the Fund may invest include
securities having the lowest ratings assigned by S&P or Moody's and, together
with comparable unrated securities, may include securities that are in default
or that face the risk of default with respect to the payment of principal or
interest. Such securities are generally unsecured and are often subordinated to
other creditors of the issuer. To the extent the Fund is required to seek
recovery upon a default in the payment of principal or interest on its portfolio
holdings, the Fund may incur additional expenses and may have limited legal
recourse in the event of a default.
Ratings of fixed income securities represent the rating agencies' opinions
regarding their quality, are not a guarantee of quality and may be reduced after
the Fund has acquired the security. Mitchell Hutchins will consider such an
event in determining whether the Fund should continue to hold the security but
is not required to dispose of it. Credit ratings attempt to evaluate the safety
of principal and interest payments and do not reflect an assessment of the
volatility of the security's market value or the liquidity of an investment in
the security. Also, NRSROs may fail to make timely changes in credit ratings in
response to subsequent events, so that an issuer's current financial condition
may be better or worse than the rating indicates.
High yield, high risk securities generally offer a higher current yield than
that available from higher grade issues, but they involve higher risks in that
they are especially subject to adverse changes in general economic conditions
and in the industries in which the issuers are engaged, to changes in the
financial condition of the issuers and to price fluctuations in response to
changes in interest rates. During periods of economic downturn or rising
interest rates, highly leveraged issuers may experience financial stress, which
could adversely affect their ability to make payments of principal and interest
and increase the possibility of default. Certain emerging market governments
that issue high yield, high risk debt securities are among the largest debtors
to commercial banks, foreign governments and supranational organizations such as
the World Bank and may not be able or willing to make principal or interest
payments as they come due.
The market for high yield, high risk securities has expanded rapidly in recent
years, and its growth paralleled a long economic expansion. In the past, the
prices of many high yield, high risk securities declined substantially,
reflecting an expectation that many issuers of such securities might experience
financial difficulties. As a result, the yields on such securities rose
dramatically. Such higher yields did not reflect the value of the income stream
that holders of such securities expected, but rather the risk that holders of
such securities could lose a substantial portion of their value as a result of
the issuers' financial restructuring or default. There can be no assurance that
such declines will not recur. The market for high yield, high risk securities
generally is thinner and less active than that for higher quality securities,
which may limit the Fund's ability to sell such securities at fair value in
response to changes in the economy or the financial markets. Adverse publicity
and investor perceptions, whether or not based on fundamental analysis, may also
decrease the values and liquidity of high yield, high risk securities,
especially in a thinly traded market.
Although Mitchell Hutchins attempts to minimize the speculative risks associated
with investments in high yield, high risk securities through securities
selection, credit analysis and attention to current trends in interest rates and
other factors, investors should consider their ability to assume these
investment risks before making an investment in the Fund.
During its 1996 fiscal year, the Fund had 86.83% of its average annual net
assets in debt securities that received a rating from S&P or Moody's or another
NRSRO and 13.17% of its net assets in debt securities that were not so rated.
The Fund had the following percentages of its net assets invested in rated
securities: AAA/Aaa (including cash items)--36.91%, AA/Aa--0.18%, A/A--0.00%,
BBB/Baa--0.74%, BB/Ba--15.29%, B/B--31.86% and CCC/Caa--1.85%. It should be
noted that this information reflects the average composition of the Fund's
assets during the fiscal year ended January 31, 1996, and is not necessarily
representative of the Fund's assets as of the end of that fiscal year, the
current fiscal year or at any time in the future.
RISKS OF FOREIGN AND EMERGING MARKET SECURITIES. The Foreign and Emerging
Market Securities in which the Fund may invest involve risks
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relating to political, social and economic developments abroad, as well as risks
resulting from the differences between the regulations to which U.S. and foreign
issuers and markets are subject. These risks may include nationalization,
expropriation, confiscatory taxation, withholding taxes on dividends and
interest, limitations on the use or transfer of Fund assets and political or
social instability or diplomatic developments, including armed conflict. Such
events have occurred in the past in countries in which the Fund is authorized to
invest and could adversely affect the Fund's assets should these conditions or
events recur. While Mitchell Hutchins intends to manage the Fund's portfolio in
a manner that will reduce the exposure to such risks, there can be no assurance
that such events will not cause the Fund to suffer a loss of interest or
principal on any of its holdings. Investors should consider their ability to
assume these investment risks before making an investment in the Fund.
Individual foreign economies may differ favorably or unfavorably from the U.S.
economy in such respects as growth of gross national product, rate of inflation,
capital reinvestment, resource self-sufficiency and balance of payments
position. Securities of many foreign companies may be less liquid and their
prices more volatile than securities of comparable U.S. companies. While the
Fund generally invests only in securities that are traded on recognized
exchanges or in over-the-counter ('OTC') markets, foreign securities may from
time to time be difficult to liquidate rapidly without significantly depressing
the price of such securities. There may be less publicly available information
concerning foreign issuers of securities held by the Fund than is available
concerning U.S. companies. Transactions in foreign securities may be subject to
less efficient settlement practices. Foreign securities trading practices,
including those involving securities settlement where Fund assets may be
released prior to receipt of payment, may expose the Fund to increased risk in
the event of a failed trade or the insolvency of a foreign broker-dealer. Legal
remedies for defaults and disputes may have to be pursued in foreign courts,
whose procedures differ substantially from those of U.S. courts.
The risks of investing in foreign securities may be greater with respect to
securities of issuers in, or denominated in the currencies of, emerging market
countries. The Fund may invest in such securities without limit. The economies
of emerging market countries generally are heavily dependent upon international
trade and, accordingly, have been and may continue to be adversely affected by
trade barriers, exchange controls, managed adjustments in relative currency
values and other protectionist measures imposed or negotiated by the countries
with which they trade. These economies also have been and may continue to be
adversely affected by economic conditions in the countries with which they
trade. Many emerging market countries have experienced substantial, and in some
periods extremely high, rates of inflation for many years. Inflation and rapid
fluctuations in inflation rates have had and may continue to have very negative
effects on the economies and securities markets of certain emerging market
countries. The securities markets of emerging market countries are substantially
smaller, less developed, less liquid and more volatile than the securities
markets of the United States and other developed countries. Disclosure and
regulatory standards in many respects are less stringent in emerging market
countries than in the United States and other major markets. There also may be a
lower level of monitoring and regulation of emerging markets and the activities
of investors in such markets, and enforcement of existing regulations may be
extremely limited. Investing in local markets, particularly in emerging market
countries, may require the Fund to adopt special procedures, seek local
government approvals or take other actions, each of which may involve additional
costs to the Fund. Certain emerging market countries may also restrict
investment opportunities in issuers in industries deemed important to national
interests.
Foreign investment in foreign debt securities is restricted or controlled to
varying degrees. These restrictions or controls may at times limit or preclude
foreign investment in certain securities and increase the costs and expenses of
the Fund. Certain countries require governmental approval prior to investments
by foreign persons, limit the amount of investment by foreign persons in a
particular issuer, limit the investment by foreign persons only to a specific
class of securities of an issuer that may have less advantageous rights than the
classes available for purchase by domiciliaries of the countries and impose
additional taxes on foreign investors. Foreign countries may require
governmental approval for the repatriation of investment income, capital or the
proceeds of sales of securities by foreign investors. In addition, if a
deterioration occurs in a foreign country's balance of payments, the country
could impose temporary restrictions on foreign capital remittances. The Fund
could be adversely affected by a delay in, or a refusal to grant, any required
governmental approval for repatriation of capital, as well as by the application
to the Fund of any restrictions on investments. Investing in local markets,
particularly in emerging market countries, may require the Fund to adopt special
procedures, seek local government approvals or take other actions, each of which
may involve additional costs to the Fund.
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PaineWebber Strategic Income Fund
Investments in Sovereign Debt involve special risks. Certain foreign countries,
particularly emerging market countries, have historically experienced, and may
continue to experience, high rates of inflation, high interest rates, exchange
rate fluctuations, large amounts of external debt, balance of payments and trade
difficulties and extreme poverty and unemployment. The issuer of the debt or the
governmental authorities that control the repayment of the debt may be unable or
unwilling to repay principal or interest when due in accordance with the terms
of such debt, and the Fund may have limited legal recourse in the event of
default.
Sovereign Debt also includes fixed income securities of 'quasi-governmental
agencies' and fixed income securities denominated in multinational currency
units of an issuer (including supranational issuers). An example of a
multinational currency unit is the European Currency Unit, which represents
specified amounts of the currencies of certain member states of the European
Union. Fixed income securities of quasi-governmental agencies are issued by
entities owned by either a national, state or equivalent government or are
obligations of a political unit that is not backed by the national government's
full faith and credit and general taxing powers.
The Fund may invest without limit in non-U.S. dollar-denominated securities.
Accordingly, changes in foreign currency exchange rates will affect the Fund's
net asset value, the value of dividends and interest earned, gains and losses
realized on the sale of securities and net investment income to be distributed
to shareholders by the Fund. If the value of a foreign currency rises against
the U.S. dollar, the value of Fund assets denominated in that currency will
increase; correspondingly, if the value of a foreign currency declines against
the U.S. dollar, the value of Fund assets denominated in that currency will
decrease. The exchange rates between the U.S. dollar and other currencies are
determined by factors such as supply and demand in the currency exchange
markets, international balances of payments, speculation and other economic and
political conditions. In addition, some foreign currency values may be volatile
and there is the possibility of governmental controls on currency exchange or
governmental intervention in currency markets. Any of these factors could
adversely affect the Fund.
RISKS OF MORTGAGE- AND ASSET-BACKED SECURITIES. The yield characteristics of
the mortgage- and asset-backed securities in which the Fund may invest differ
from those of traditional debt securities. Among the major differences are that
interest and principal payments are made more frequently on mortgage- and
asset-backed securities, usually monthly, and that principal may be prepaid at
any time because the underlying mortgage loans or other assets generally may be
prepaid at any time. As a result, if the Fund purchases these securities at a
premium, a prepayment rate that is faster than expected will reduce yield to
maturity, while a prepayment rate that is slower than expected will have the
opposite effect of increasing the yield to maturity. Conversely, if the Fund
purchases these securities at a discount, faster than expected prepayments will
increase, while slower than expected prepayments will reduce, yield to maturity.
Amounts available for reinvestment by the Fund are likely to be greater during a
period of declining interest rates and, as a result, are likely to be reinvested
at lower interest rates than during a period of rising interest rates. The
market for privately issued mortgage- and asset-backed securities is smaller and
less liquid than the market for U.S. government mortgage-backed securities. CMO
classes may be specially structured in a manner that provides any of a wide
variety of investment characteristics, such as yield, effective maturity and
interest rate sensitivity. As market conditions change, however, and
particularly during periods of rapid or unanticipated changes in market interest
rates, the attractiveness of the CMO classes and the ability of the structure to
provide the anticipated investment characteristics may be significantly reduced.
These changes can result in volatility in the market value, and in some
instances reduced liquidity, of the CMO class.
Certain classes of CMOs and other mortgage-backed securities are structured in a
manner that makes them extremely sensitive to changes in prepayment rates.
Interest-only ('IO') and principal-only ('PO') classes are examples of this. IOs
are entitled to receive all or a portion of the interest, but none (or only a
nominal amount) of the principal payments, from the underlying mortgage assets.
If the mortgage assets underlying an IO experience greater than anticipated
principal prepayments, then the total amount of interest payments allocable to
the IO class, and therefore the yield to investors, generally will be reduced.
In some instances, an investor in an IO may fail to recoup all of his or her
initial investment, even if the security is government issued or guaranteed or
is rated AAA or the equivalent. Conversely, PO classes are entitled to receive
all or a portion of the principal payments, but none of the interest, from the
underlying mortgage assets. PO classes are purchased at substantial discounts
from par, and the yield to investors will be reduced if principal payments are
slower than expected. Some IOs and POs, as well as other CMO classes, are
structured to have special protections against the effects of prepayments. These
structural protections, however, normally are effective only within certain
ranges
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of prepayment rates and thus will not protect investors in all circumstances.
Some CMO classes are structured to pay interest at rates that are adjusted in
accordance with a formula, such as a multiple or fraction of the change in a
specified interest rate index, so as to pay at a rate that will be attractive in
certain interest rate environments but not in others. For example, an inverse
floating rate CMO class pays interest at a rate that increases as a specified
interest rate index decreases but decreases as that index increases. For other
CMO classes, the yield may move in the same direction as market interest
rates--i.e., the yield may increase as rates increase and decrease as rates
decrease--but may do so more rapidly or to a greater degree. The market value of
such securities generally is more volatile than that of a fixed rate obligation.
Such interest rate formulas may be combined with other CMO characteristics. For
example, a CMO class may be an 'inverse IO,' on which the holders are entitled
to receive no payments of principal and are entitled to receive interest at a
rate that will vary inversely with a specified index or a multiple thereof.
During 1994, the value and liquidity of many mortgage-backed securities declined
sharply due primarily to increases in interest rates. There can be no assurance
that such declines will not recur. The market value of certain mortgage-backed
securities in which the Fund may invest, including IO and PO classes of
mortgage-backed securities and inverse floating rate securities, can be
extremely volatile and these securities may become illiquid. Mitchell Hutchins
seeks to manage the Fund so that the volatility of the Fund's portfolio, taken
as a whole, is consistent with the Fund's investment objectives. If market
interest rates or other factors that affect the volatility of securities held by
the Fund change in ways that Mitchell Hutchins does not anticipate, the Fund's
ability to meet its investment objectives may be reduced.
See Appendix B to this Prospectus for more information concerning the types of
mortgage-backed securities in which the Fund may invest.
ILLIQUID SECURITIES. The Fund may invest up to 15% of its net assets in
illiquid securities. The term 'illiquid securities' for this purpose means
securities that cannot be disposed of within seven days in the ordinary course
of business at approximately the price at which the Fund has valued the
securities. Under current guidelines of the staff of the SEC, IOs and POs are
considered illiquid. However, IO and PO classes of fixed-rate mortgage-backed
securities issued by the U.S. government or one of its agencies or
instrumentalities will not be considered illiquid if Mitchell Hutchins has
determined that they are liquid pursuant to guidelines established by the
Trust's board of trustees. Illiquid securities also are considered to include,
among other things, written OTC options, repurchase agreements with maturities
in excess of seven days and securities whose disposition is restricted under the
federal securities laws (other than 'Rule 144A' securities that Mitchell
Hutchins has determined to be liquid under procedures approved by the Trust's
board of trustees).
Rule 144A established a 'safe harbor' from the requirements of the Securities
Act of 1933 ('1933 Act'). Institutional markets for restricted securities have
developed as a result of Rule 144A, providing both readily ascertainable values
for restricted securities and the ability to liquidate an investment to satisfy
share redemption orders. An insufficient number of qualified institutional
buyers interested in purchasing Rule 144A-eligible restricted securities held by
the Fund, however, could affect adversely the marketablility of such portfolio
securities and the Fund might be unable to dispose of such securities promptly
or at favorable prices.
The Fund may not be able to sell illiquid securities when Mitchell Hutchins
considers it desirable to do so or may have to sell such securities at a price
lower than could be obtained if they were more liquid. Also, the sale of
illiquid securities may require more time and may result in higher dealer
discounts and other selling expenses than does the sale of securities that are
liquid. Illiquid securities may be more difficult to value due to the
unavailability of reliable market quotations for such securities.
HEDGING AND RELATED INCOME STRATEGIES. The Fund may use options (both
exchange-traded and OTC) and futures contracts to attempt to enhance income and
may use these instruments and forward currency contracts to reduce the overall
risk of its investments (hedge). Hedging strategies may be used in an attempt to
manage the Fund's average duration, foreign currency exposure and other risks of
the Fund's investments, which can affect fluctuations in the Fund's net asset
value. The Fund's ability to use these strategies may be limited by market
conditions, regulatory limits and tax considerations. The use of options and
futures solely to enhance income may be considered a form of speculation.
Appendix C to this Prospectus describes these instruments and the Statement of
Additional Information contains further information on these strategies.
The Fund may purchase and sell call and put options on securities indices and on
individual securities for hedging purposes or to enhance income. The Fund also
may purchase and sell interest rate and currency futures contracts and options
thereon and may purchase and sell
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covered straddles on securities, bond indices or currencies or options on such
futures contracts. The Fund may enter into options, futures contracts and
forward currency contracts under which up to 100% of the Fund's portfolio is at
risk.
The Fund may enter into forward currency contracts for the purchase or sale of a
specified currency at a specified future date, either with respect to specific
transactions or with respect to its portfolio positions. For example, when
Mitchell Hutchins anticipates making a currency exchange transaction in
connection with the purchase or sale of a security, the Fund may enter into a
forward contract in order to set the exchange rate at which the transaction will
be made. The Fund also may enter into a forward contract to sell an amount of a
foreign currency approximating the value of some or all of the Fund's securities
positions denominated in such currency. The Fund may use forward contracts in
one currency or a basket of currencies to hedge against fluctuations in the
value of another currency when Mitchell Hutchins anticipates there will be a
correlation between the two and may use forward currency contracts to shift the
Fund's exposure to foreign currency fluctuations from one country to another.
The purpose of entering into these contracts is to minimize the risk to the Fund
from adverse changes in the relationship between the U.S. and foreign
currencies. The Fund may also purchase and sell foreign currency futures
contracts, options thereon and options on foreign currencies to hedge against
the risk of fluctuations in market value of foreign securities the Fund holds in
its portfolio, or that it intends to purchase, resulting from changes in foreign
exchange rates. In addition, the Fund may purchase and sell options on foreign
currencies to enhance income.
The Fund may enter into interest rate protection transactions, including
interest rate swaps, caps, collars and floors, to preserve a return or spread on
a particular investment or portion of its portfolio or to protect against any
increase in the price of securities the Fund anticipates purchasing at a later
date. The Fund will enter into interest rate protection transactions only with
banks and recognized securities dealers believed by Mitchell Hutchins to present
minimal credit risks in accordance with guidelines established by the Trust's
board of trustees.
The Fund might not employ any of the strategies described above, and no
assurance can be given that any strategy used will succeed. If Mitchell Hutchins
incorrectly forecasts interest or currency exchange rates, market values or
other economic factors in utilizing a strategy for the Fund, the Fund would be
in a better position if it had not entered into the transaction. The use of
these strategies involves certain special risks, including (1) the fact that
skills needed to use hedging instruments are different from those needed to
select the Fund's securities, (2) possible imperfect correlation, or even no
correlation, between price movements of hedging instruments and price movements
of the investments being hedged, (3) the fact that, while hedging strategies can
reduce the risk of loss, they can also reduce the opportunity for gain, or even
result in losses, by offsetting favorable price movements in hedged investments
and (4) the possible inability of the Fund to purchase or sell a portfolio
security at a time that otherwise would be favorable for it to do so, or the
possible need for the Fund to sell a portfolio security at a disadvantageous
time, due to the need for the Fund to maintain 'cover' or to segregate
securities in connection with hedging transactions and the possible inability of
the Fund to close out or to liquidate its hedged position. Only a limited
market, if any, currently exists for hedging instruments relating to securities
or currencies in most emerging market countries. Accordingly, under present
circumstances, the Fund does not anticipate that it will be able to effectively
hedge its currency exposure or investment in such markets.
REPURCHASE AGREEMENTS. The Fund may use repurchase agreements. Repurchase
agreements are transactions in which the Fund purchases securities from a bank
or recognized securities dealer and simultaneously commits to resell the
securities to the bank or dealer at an agreed-upon date and price reflecting a
market rate of interest unrelated to the coupon rate or maturity of the
purchased securities. Repurchase agreements carry certain risks not associated
with direct investments in securities, including possible decline in the market
value of the underlying securities and delays and costs to the Fund if the other
party to the repurchase agreement becomes insolvent. The Fund intends to enter
into repurchase agreements only with banks and dealers in transactions believed
by Mitchell Hutchins to present minimum credit risks in accordance with
guidelines established by the Trust's board of trustees.
ARBITRAGED DOLLAR ROLLS AND REVERSE REPURCHASE AGREEMENTS. The Fund may enter
into dollar rolls, in which the Fund sells mortgage-backed or other securities
for delivery in the current month and simultaneously contracts to purchase
substantially similar securities on a specified future date. In the case of
dollar rolls involving mortgage-backed securities, the mortgage-backed
securities that are purchased will be of the same type and will have the same
interest rate and maturity as those sold, but will be supported by different
pools of mortgages. The Fund forgoes principal and interest paid during the roll
period on the securities sold, but the
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PaineWebber Strategic Income Fund
Fund is compensated by the difference between the current sales price and the
lower price for the future purchase as well as by any interest earned on the
proceeds of the securities sold. The Fund also could be compensated through the
receipt of fee income equivalent to a lower forward price.
The Fund may also enter into reverse repurchase agreements in which the Fund
sells securities to a bank or dealer and agrees to repurchase them at a mutually
agreed-upon date and price. The market value of securities sold under reverse
repurchase agreements typically is greater than the proceeds of the sale, and,
accordingly, the market value of the securities sold is likely to be greater
than the value of the securities in which the Fund invests those proceeds. Thus,
reverse repurchase agreements involve the risk that the buyer of the securities
sold by the Fund might be unable to deliver them when the Fund seeks to
repurchase. In the event the buyer of securities under a reverse repurchase
agreement files for bankruptcy or becomes insolvent, such buyer or its trustee
or receiver may receive an extension of time to determine whether to enforce the
Fund's obligation to repurchase the securities, and the Fund's use of the
proceeds of the reverse repurchase agreement may effectively be restricted
pending such decision.
The dollar rolls and reverse repurchase agreements entered into by the Fund
normally will be arbitrage transactions in which the Fund will maintain an
offsetting position in U.S. Government and Investment Grade Securities or
repurchase agreements involving U.S. Government and Investment Grade Securities
that mature on or before the settlement date of the related dollar roll or
reverse repurchase agreement. Since the Fund will receive interest on the
securities or repurchase agreements in which it invests the transaction
proceeds, such transactions may involve leverage. However, because such U.S.
Government and Investment Grade Securities or repurchase agreements will mature
on or before the settlement date of the dollar roll or reverse repurchase
agreement, Mitchell Hutchins believes that such arbitrage transactions do not
present the risks to the Fund that are associated with other types of leverage.
Dollar rolls and reverse repurchase agreements will be considered to be
borrowings and, accordingly, will be subject to the Fund's limitations on
borrowings, which will restrict the aggregate of such transactions (plus any
other borrowings) to 33 1/3% of the Fund's total assets. The Fund will not enter
into dollar rolls or reverse repurchase agreements, other than in arbitrage
transactions as described above, in an aggregate amount in excess of 5% of the
Fund's total assets. The Fund has no present intention to enter into dollar
rolls other than in such arbitrage transactions, and it has no present intention
to enter into reverse repurchase agreements other than in such arbitrage
transactions or for temporary or emergency purposes. The Fund may borrow money
for temporary purposes, but not in excess of 10% of its total assets.
ZERO COUPON, OTHER ORIGINAL ISSUE DISCOUNT AND PAYMENT-IN-KIND SECURITIES. The
Fund may invest up to 35% of its total assets in zero coupon securities. It also
may invest without limit in other securities that are issued with original issue
discount ('OID') and in payment-in-kind ('PIK') securities. Zero coupon
securities usually trade at a substantial discount from their face or par value;
PIK securities often trade at a substantial discount from their face or par
value. Both zero coupon and PIK securities are subject to greater fluctuations
of market value in response to changing interest rates than debt obligations of
comparable maturities that make current distributions of interest in cash.
Federal tax law requires that a holder of a security with OID accrue a portion
of the OID on the security as income each year, even though the holder may
receive no interest payment on the security during the year. Accordingly,
although the Fund will receive no payments on its zero coupon securities prior
to their maturity or disposition, it will have income attributable to such
securities. Similarly, while PIK securities may pay interest in the form of
additional securities rather than cash, that interest must be included in the
Fund's annual income.
Federal tax law requires that companies such as the Fund, which seek to qualify
for pass-through federal income tax treatment as regulated investment companies,
distribute substantially all of their net investment income each year, including
non-cash income. Accordingly, the Fund will be required, in order to maintain
the desired tax treatment, to include in its dividends an amount equal to the
income attributable to its zero coupon, other OID and PIK securities. See
'Taxes' in the Statement of Additional Information. Those dividends will be paid
from the cash assets of the Fund or by liquidation of portfolio securities, if
necessary, at a time when the Fund otherwise would not have done so.
LOAN PARTICIPATIONS AND ASSIGNMENTS. The Fund may invest in fixed and floating
rate loans ('Loans') arranged through private negotiations between a U.S. or
foreign borrower and one or more financial institutions ('Lenders'). The Fund's
investments in Loans are expected in most instances to be in the form of
participations in Loans ('Participations') and assignments of all or a portion
of Loans ('Assignments') from third parties. Participations typically will
result in the Fund's
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PaineWebber Strategic Income Fund
having a contractual relationship only with the Lender, not with the borrower.
The Fund will have the right to receive payments of principal, interest and any
fees to which it is entitled only from the Lender selling the Participation and
only upon receipt by the Lender of the payments from the borrower. In connection
with purchasing Participations, the Fund generally has no direct right to
enforce compliance by the borrower with the terms of the loan agreement relating
to the Loan ('Loan Agreement'), nor any rights of set-off against the borrower,
and the Fund may not directly benefit from any collateral supporting the Loan in
which it has purchased the Participation. As a result, the Fund will assume the
credit risk of both the borrower and the Lender that is selling the
Participation. In the event of the insolvency of the Lender selling a
Participation, the Fund may be treated as a general creditor of the Lender and
may not benefit from any set-off between the Lender and the borrower. The Fund
will acquire Participations only if the Lender interpositioned between the Fund
and the borrower is determined by Mitchell Hutchins to be creditworthy. When the
Fund purchases Assignments from Lenders, the Fund will acquire direct rights
against the borrower on the Loan. However, since Assignments are arranged
through private negotiations between potential assignees and assignors, the
rights and obligations acquired by the Fund as the purchaser of an Assignment
may differ from, and be more limited than, those held by the assigning Lender.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. The Fund may purchase securities
on a 'when-issued' basis or may purchase or sell securities on a 'delayed
delivery' basis, i.e., for issuance or delivery to the Fund later than the
normal settlement date for such securities at a stated price and yield. The Fund
generally would not pay for such securities or start earning interest on them
until they are received. However, when the Fund undertakes a when-issued or
delayed delivery obligation, it immediately assumes the risks of ownership,
including the risk of price fluctuation. Failure of the issuer to deliver a
security purchased by the Fund on a when-issued or delayed delivery basis may
result in the Fund's incurring a loss or missing an opportunity to make an
alternative investment. Depending on market conditions, the Fund's when-issued
and delayed delivery purchase commitments could cause its net asset value per
share to be more volatile, because such securities may increase the amount by
which the Fund's total assets, including the value of when-issued and delayed
delivery securities held by the Fund, exceed its net assets.
CONVERTIBLE SECURITIES. The Fund may invest in convertible securities, which
are bonds, debentures, notes, preferred stocks or other securities that may be
converted into or exchanged for a specified amount of common stock of the same
or a different issuer within a particular period of time at a specified price or
formula. A convertible security entitles the holder to receive interest normally
paid or accrued on debt or the dividend paid on preferred stock until the
convertible security matures or is redeemed, converted or exchanged. Convertible
securities have unique investment characteristics in that they generally (1)
have higher yields than common stocks, but lower yields than comparable
non-convertible securities, (2) are less subject to fluctuation in value than
the underlying stock since they have fixed income characteristics, and (3)
provide the potential for capital appreciation if the market price of the
underlying common stock increases. Most convertible securities currently are
issued by U.S. companies, although a substantial Eurodollar convertible
securities market has developed, and the markets for convertible securities
denominated in local currencies are increasing.
DERIVATIVES. The Fund may invest in instruments or securities that commonly are
referred to as 'derivatives' because their value depends on (or 'derives' from )
the value of an underlying asset, reference rate or index. Derivative
instruments include options, futures contracts, interest rate protection
contracts and similar instruments that may be used by the Fund in hedging and
related income strategies. There is only limited consensus as to what
constitutes a 'derivative' security. However, in Mitchell Hutchins' view, the
derivative securities in which the Fund may invest include 'stripped'
securities, such as CATS and TIGRs, specially structured types of mortgage- and
asset-backed securities, such as IOs, POs and inverse floaters, and securities
denominated in one currency whose value is linked to another currency. The
market value of derivative instruments and securities sometimes is more volatile
than that of other investments, and each type of derivative may pose its own
special risks. Mitchell Hutchins takes these risks into account in its
management of the Fund.
OTHER SECURITIES. The Fund may invest up to 10% of its total assets in
preferred stock of U.S. and foreign companies. Preferred stock generally has a
preference as to dividends and upon liquidation over an issuer's common stock
but ranks junior to debt securities in an issuer's capital structure. Preferred
stock generally pays dividends in cash (or other shares of preferred stock) at a
defined rate but, unlike interest payments on debt securities, preferred stock
dividends are payable only if declared by the issuer's board of directors.
Dividends on preferred stock may be cumulative, meaning that, in the event the
issuer fails to make one or more dividend payments on the preferred stock, no
dividends may be paid on the issuer's common stock until all unpaid
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PaineWebber Strategic Income Fund
preferred stock dividends have been paid. Preferred stock also may provide that,
in the event the issuer fails to make a specified number of dividend payments,
the holders of the preferred stock will have the right to elect a specified
number of directors to the issuer's board. Preferred stock also may be subject
to optional or mandatory redemption provisions.
The Fund may invest in debt securities issued by banks and other business
entities that are indexed to specific foreign currency exchange rates. The terms
of such securities provide that their principal amount is adjusted upwards or
downwards (but not below zero) at maturity to reflect changes in the exchange
rate between two currencies while the obligations are outstanding. While such
securities offer the potential for an attractive rate of return, they also
entail the risk of loss of principal. New forms of such securities continue to
be developed. The Fund may invest in such securities to the extent consistent
with its investment objectives. The Fund may acquire equity securities
(including common stocks and rights and warrants for equity securities, debt
securities and commodities) when attached to fixed income securities or as part
of a unit including fixed income securities, or in connection with a conversion
or exchange of fixed income securities. The Fund also may invest in certificates
of deposit issued by banks and savings associations and in banker's acceptances.
Under normal circumstances, the Fund invests at least 65% of its total assets in
income producing securities, including zero coupon and PIK securities.
LENDING OF PORTFOLIO SECURITIES. The Fund is authorized to lend up to 33 1/3%
of the total value of its portfolio securities to broker-dealers or
institutional investors that Mitchell Hutchins deems qualified. Lending
securities enables the Fund to earn additional income, but could result in a
loss or delay in recovering the securities.
OTHER INFORMATION. The Fund may implement various temporary defensive
strategies at times when Mitchell Hutchins determines that conditions in the
markets make pursuing the Fund's basic investment strategy inconsistent with the
best interests of its shareholders. The Fund may commit all or any portion of
its assets to cash, denominated in U.S. dollars or foreign currencies, or money
market instruments of U.S. or foreign issuers, including repurchase agreements,
for such temporary, defensive purposes or for liquidity purposes, such as
clearance of portfolio transactions, the payment of dividends and expenses and
redemptions. The Fund also may engage in short sales of securities 'against the
box' to defer realization of gains or losses for tax purposes.
New types of mortgage- and asset-backed securities, derivative securities,
hedging instruments and risk management techniques are developed and marketed
from time to time. The Fund may invest in these securities and instruments and
use these techniques to the extent consistent with its investment objectives and
limitations and with regulatory and tax considerations.
The Fund is 'non-diversified,' as defined in the 1940 Act, but intends to
continue to qualify as a regulated investment company for federal income tax
purposes. See 'Taxes' in the Statement of Additional Information. This means, in
general, that more than 5% of the Fund's total assets may be invested in
securities of one issuer but only if, at the close of each quarter of the Fund's
taxable year, the aggregate amount of such holdings does not exceed 50% of the
value of its total assets and no more than 25% of the value of its total assets
is invested in the securities of a single issuer. To the extent that the Fund's
portfolio at times may include the securities of a smaller number of issuers
than if it were 'diversified' (as defined in the 1940 Act), the Fund will at
such times be subject to greater risk with respect to its portfolio securities
than an investment company that invests in a broader range of securities,
because changes in the financial condition or market assessment of a single
issuer may cause greater fluctuations in the net asset value of the Fund's
shares.
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PURCHASES
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GENERAL. Class A shares are sold to investors subject to an initial sales
charge. Class B shares are sold without an initial sales charge but are subject
to higher ongoing expenses than Class A shares and a contingent deferred sales
charge payable upon certain redemptions. Class B shares automatically convert to
Class A shares approximately six years after issuance. Class C shares are sold
without an initial sales charge but are subject to higher ongoing expenses than
Class A shares and a contingent deferred sales charge of 0.75% payable on
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PaineWebber Strategic Income Fund
most redemptions made within one year of purchase. Class C shares do not convert
into another Class.
See 'Flexible Pricing System' and 'Conversion of Class B Shares.'
Shares of the Fund are available through PaineWebber and its correspondent firms
or, for shareholders who are not PaineWebber clients, through the Transfer
Agent. Investors may contact a local PaineWebber office to open an account. The
minimum initial investment for the Fund is $1,000 and the minimum for additional
purchases is $100. These minimums may be waived or reduced for investments by
employees of PaineWebber or its affiliates, certain pension plans and retirement
accounts and participants in the Fund's automatic investment plan. Purchase
orders will be priced at the net asset value per share next determined (see
'Valuation of Shares') after the order is received by PaineWebber's New York
City offices or by the Transfer Agent, plus any applicable sales charge for
Class A shares. The Fund and Mitchell Hutchins reserve the right to reject any
purchase order and to suspend the offering of Fund shares for a period of time.
When placing purchase orders, investors should specify whether the order is for
Class A, Class B or Class C shares. All share purchase orders that fail to
specify a Class will automatically be invested in Class A shares.
PURCHASES THROUGH PAINEWEBBER OR CORRESPONDENT FIRMS. Purchases through
PaineWebber investment executives or correspondent firms may be made in person
or by mail, telephone or wire; the minimum wire purchase is $1 million.
Investment executives and correspondent firms are responsible for transmitting
purchase orders to PaineWebber's New York City offices promptly. Investors may
pay for purchases with checks drawn on U.S. banks or with funds held in
brokerage accounts at PaineWebber or its correspondent firms. Payment is due on
the third Business Day after the order is received. A 'Business Day' is any day,
Monday through Friday, on which the New York Stock Exchange, Inc. ('NYSE') is
open for business.
PURCHASES THROUGH THE TRANSFER AGENT. Investors who are not PaineWebber clients
may purchase Fund shares and set up an account through the Transfer Agent, by
completing and signing an account application which the investor may obtain by
calling 1-800-647-1568. The application and check to cover the purchase must be
mailed to PFPC Inc., Attn: PaineWebber Mutual Funds, P.O. Box 8950, Wilmington,
Delaware 19899.
INITIAL SALES CHARGE--CLASS A SHARES. The public offering price of Class A
shares is the next determined net asset value, plus any applicable sales charge,
which will vary with the size of the purchase as shown in the following table:
INITIAL SALES CHARGE SCHEDULE--
CLASS A SHARES
<TABLE>
<CAPTION>
SALES CHARGES AS A
PERCENTAGE OF DISCOUNT TO
---------------------- SELECTED
NET AMOUNT DEALERS AS A
INVESTED PERCENTAGE
OFFERING (NET ASSET OF OFFERING
AMOUNT OF PURCHASE PRICE VALUE) PRICE
- ---------------------- -------- ---------- ------------
<S> <C> <C> <C>
Less than $100,000 4.00% 4.17% 3.75%
$100,000 to $249,999 3.00 3.09 2.75
$250,000 to $499,999 2.25 2.30 2.00
$500,000 to $999,999 1.75 1.78 1.50
$1,000,000 and over(1) None None 1.00
</TABLE>
- ------------------
(1) Mitchell Hutchins pays compensation to PaineWebber out of its own resources.
Most redemptions of these shares within one year of purchase will be subject
to a contingent deferred sales charge of 1.0%. See 'Contingent Deferred
Sales Charge--Class A Shares.'
Mitchell Hutchins may at times agree to reallow a higher discount to
PaineWebber, as exclusive dealer for the Fund's shares, than those shown above.
To the extent PaineWebber or any dealer receives 90% or more of the sales
charge, it may be deemed an 'underwriter' under the Securities Act of 1933.
REDUCED SALES CHARGE PLANS--CLASS A SHARES. If an investor or eligible group of
related Fund investors purchases Class A shares of the Fund concurrently with
Class A shares of other PaineWebber mutual funds, the purchases may be combined
to take advantage of the reduced sales charge applicable to larger purchases. In
addition, the right of accumulation permits a Fund investor or eligible group of
related Fund investors to pay the lower sales charge applicable to larger
purchases by basing the sales charge on the dollar amount of Class A shares
currently being purchased, plus the net asset value of the investor's or group's
total existing Class A shareholdings in other PaineWebber mutual funds.
An 'eligible group of related Fund investors' includes an individual, the
individual's spouse, parents and children, the individual's individual
retirement account ('IRA'), certain companies controlled by the individual and
employee benefit plans of those companies, and trusts or Uniform Gifts to Minors
Act/Uniform Transfers to Minors Act accounts created by the individual or
eligible group of individuals for the benefit of the individual and/or the
individual's spouse, parents or children. The term also includes a group of
related employers and one or more qualified retirement plans of such employers.
For more information, an investor should consult the Statement of Additional
Information or contact a PaineWebber investment executive or correspondent firm
or the Transfer Agent.
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PaineWebber Strategic Income Fund
SALES CHARGE WAIVERS--CLASS A SHARES. Class A shares of the Fund are available
without a sales charge through exchanges for Class A shares of most other
PaineWebber mutual funds. See 'Exchanges.' In addition, Class A shares may be
purchased without a sales charge, and exchanges of any Class of shares made
without the $5.00 exchange fee, by employees, directors and officers of
PaineWebber or its affiliates, directors or trustees and officers of any
PaineWebber mutual fund, their spouses, parents and children and advisory
clients of Mitchell Hutchins.
Class A shares may also be purchased without a sales charge by employee benefit
plans qualified under section 401 or 403(b) of the Internal Revenue Code (the
'Code'), including salary reduction plans qualified under section 401(k) of the
Code, subject to minimum requirements established by Mitchell Hutchins with
respect to number of employees or amount of purchase. Currently, the employers
establishing the plan must have 100 or more eligible employees or the amount
invested or to be invested during the subsequent 13-month period in the Fund or
any other PaineWebber mutual fund must total at least $1 million. If investments
by an employee benefit plan without a sales charge are made through a dealer
(including PaineWebber) who has executed a dealer agreement with Mitchell
Hutchins, Mitchell Hutchins may make a payment, out of its own resources, to the
dealer in an amount not to exceed 1% of the amount invested.
Class A shares also may be purchased without a sales charge if the purchase is
made through a PaineWebber investment executive who formerly was employed as a
broker with another firm registered as a broker-dealer with the SEC, provided
(1) the purchaser was the investment executive's client at the competing
brokerage firm, (2) within 90 days of the purchase of Class A shares the
purchaser redeemed shares of one or more mutual funds for which that competing
firm or its affiliates was principal underwriter, provided the purchaser either
paid a sales charge to invest in those funds, paid a contingent deferred sales
charge upon redemption or held shares of those funds for the period required not
to pay the otherwise applicable contingent deferred sales charge and (3) the
total amount of shares of all PaineWebber mutual funds purchased under this
sales charge waiver does not exceed the amount of the purchaser's redemption
proceeds from the competing firm's funds. To take advantage of this waiver, an
investor must provide satisfactory evidence that all the above-noted conditions
are met. Qualifying investors should contact their PaineWebber investment
executives for more information.
Certificate holders of unit investment trusts ('UITs') sponsored by PaineWebber
may acquire Class A shares of the Fund without regard to minimum investment
requirements and without sales charges by electing to have dividends and other
distributions from their UIT investment automatically invested in Class A
shares.
Class A shares may be acquired without a sales charge if issued by the Fund in
connection with a reorganization pursuant to which the Fund acquires
substantially all of the assets and liabilities of another investment company in
exchange solely for shares of the Fund.
CONTINGENT DEFERRED SALES CHARGE--CLASS A SHARES. Class A shares purchased
without an initial sales charge due to the sales charge waiver for purchases of
$1 million or more and held less than one year are subject to a contingent
deferred sales charge upon redemption equal to 1% of the lower of (a) the net
asset value of the shares at the time of purchase or (b) the net asset value of
the shares at the time of redemption. The holding period of Class A shares
acquired through an exchange with another PaineWebber mutual fund is calculated
from the date the Class A shares of the other PaineWebber mutual fund were
initially purchased without a sales charge, and Class A shares acquired through
an exchange will be considered to represent, as applicable, reinvestments of
dividends or other distributions in such other funds. Redemption order will be
determined as described for Class B shares of the Fund (see 'Contingent Deferred
Sales Charge--Class B Shares'). Class A shares held one year or longer and Class
A shares acquired through reinvestment of dividends or other distributions are
not subject to this contingent deferred sales charge. The contingent deferred
sales charge is waived for exchanges, as described below, and for most
redemptions in connection with the systematic withdrawal plan. THIS CONTINGENT
DEFERRED SALES CHARGE DOES NOT APPLY TO REDEMPTIONS OF CLASS A SHARES PURCHASED
PRIOR TO NOVEMBER 10, 1995. The amount of any contingent deferred sales charge
will be paid to Mitchell Hutchins.
CONTINGENT DEFERRED SALES CHARGE--CLASS B SHARES. The public offering price of
the Class B shares of the Fund is the next determined net asset value, and no
initial sales charge is imposed. A contingent deferred sales charge, however, is
imposed upon most redemptions of Class B shares.
The maximum contingent deferred sales charge for Class B shares equals 5% of the
lower of (a) the net asset value of the shares at the time of purchase or (b)
the net asset value of the shares at the time of redemption. Class B shares held
six years or longer and Class B shares acquired through reinvestment of
dividends or other
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PaineWebber Strategic Income Fund
distributions are not subject to the contingent deferred sales charge. The
following table shows the contingent deferred sales charge percentages charged
in each year following purchase:
<TABLE>
<CAPTION>
CONTINGENT DEFERRED
SALES CHARGE AS A
REDEMPTION PERCENTAGE OF NET
DURING ASSET VALUE
- -------------------------------------- -------------------
<S> <C>
1st Year Since Purchase............... 5%
2nd Year Since Purchase............... 4
3rd Year Since Purchase............... 3
4th Year Since Purchase............... 2
5th Year Since Purchase............... 2
6th Year Since Purchase............... 1
7th Year Since Purchase............... None
</TABLE>
In determining the applicability and rate of any contingent deferred sales
charge, it will be assumed that a redemption is made first of Class B shares
representing the reinvestment of dividends and other distributions and then of
other shares held by the shareholder for the longest period of time. The holding
period of Class B shares acquired through an exchange with another PaineWebber
mutual fund will be calculated from the date that the Class B shares were
initially acquired in one of the other PaineWebber mutual funds, and Class B
shares being redeemed will be considered to represent, as applicable, dividend
and other distribution reinvestments in such other funds. This will result in
any contingent deferred sales charge being imposed at the lowest possible rate.
The amount of any contingent deferred sales charge will be paid to Mitchell
Hutchins.
SALES CHARGE WAIVERS--CLASS B SHARES. The contingent deferred sales charge will
be waived for exchanges, as described below, and for most redemptions in
connection with the Fund's systematic withdrawal plan. In addition, the
contingent deferred sales charge will be waived for a total or partial
redemption made within one year of the death of the shareholder. The contingent
deferred sales charge waiver is available where the decedent is either the sole
shareholder or owns the shares with his or her spouse as a joint tenant with
right of survivorship. This waiver applies only to redemption of shares held at
the time of death. The contingent deferred sales charge will also be waived in
connection with a lump-sum or other distribution in the case of an IRA, a
self-employed individual retirement plan (so-called 'Keogh Plan') or a custodial
account under section 403(b) of the Code following attainment of age 59 1/2; a
total or partial redemption resulting from a distribution following retirement
in the case of a tax-qualified retirement plan; and any redemption resulting
from a tax-free return of an excess contribution to an IRA.
Contingent deferred sales charge waivers will be granted subject to confirmation
(by PaineWebber in the case of shareholders who are PaineWebber clients or by
the Transfer Agent in the case of all other shareholders) of the shareholders'
status or holdings, as the case may be.
PURCHASE OF CLASS C SHARES. The public offering price of the Class C shares is
the next determined net asset value. No initial sales charge is imposed.
CONTINGENT DEFERRED SALES CHARGE--CLASS C SHARES. Class C shares held less than
one year will be subject to a contingent deferred sales charge on redemptions in
an amount equal to 0.75% of the lower of (a) the net asset value of the shares
at the time of purchase or (b) the net asset value of the shares at the time of
redemption. The holding period of Class C shares acquired through an exchange
with another PaineWebber mutual fund is calculated from the date the Class C
shares of the other PaineWebber mutual fund were initially purchased, and Class
C shares will be considered to represent, as applicable, dividend and other
distribution reinvestments in such other funds. Redemption order will be
determined as described for Class B shares (see 'Contingent Deferred Sales
Charge-- Class B Shares'). The amount of the contingent deferred sale charges
imposed on redemptions of Class C shares may be different for other PaineWebber
mutual funds. Redemptions of Class C shares acquired through an exchange and
held less than one year will be subject to the same contingent deferred sales
charge that would have been imposed on Class C shares of the PaineWebber mutual
fund originally purchased. Class C shares held one year or longer and Class C
shares acquired through reinvestment of dividends or other distributions are not
subject to this contingent deferred sales charge. The contingent deferred sales
charge is waived for exchanges, as described below, and for most redemptions in
connection with the systematic withdrawal plan. THIS CONTINGENT DEFERRED SALES
CHARGE DOES NOT APPLY TO REDEMPTIONS OF CLASS C SHARES PURCHASED PRIOR TO
NOVEMBER 10, 1995. The amount of any contingent deferred sales charge will be
paid to Mitchell Hutchins.
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PaineWebber Strategic Income Fund
EXCHANGES
- --------------------------------------------------------------------------------
Shares of the Fund may be exchanged for shares of the corresponding Class of
other PaineWebber mutual funds, or may be acquired through an exchange of shares
of the corresponding Class of those funds. No initial sales charge is imposed on
the shares acquired, and no contingent deferred sales charge is imposed on the
shares being disposed of, through an exchange. However, contingent deferred
sales charges may apply to redemptions of shares of PaineWebber mutual funds
acquired through an exchange. A $5.00 exchange fee is charged for each exchange,
and exchanges may be subject to minimum investment requirements of the fund into
which exchanges are made.
The other PaineWebber mutual funds with which Fund shares may be exchanged
include the following:
PAINEWEBBER INCOME FUNDS
o Global Income Fund
o High Income Fund
o Investment Grade Income Fund
o Low Duration U.S. Government Income Fund
o U.S. Government Income Fund
PAINEWEBBER TAX-FREE INCOME FUNDS
o California Tax-Free Income Fund
o Municipal High Income Fund
o National Tax-Free Income Fund
o New York Tax-Free Income Fund
PAINEWEBBER GROWTH FUNDS
o Capital Appreciation Fund
o Emerging Markets Equity Fund
o Financial Services Growth Fund
o Global Equity Fund
o Growth Fund
o Small Cap Growth Fund
o Small Cap Value Fund
PAINEWEBBER GROWTH AND INCOME FUNDS
o Balanced Fund
o Growth and Income Fund
o Tactical Allocation Fund
o Utility Income Fund
PAINEWEBBER MONEY MARKET FUND
PaineWebber clients must place exchange orders through their PaineWebber
investment executives or correspondent firms. Shareholders who are not
PaineWebber clients must place exchange orders in writing with the Transfer
Agent: PFPC Inc., Attn: PaineWebber Mutual Funds, P.O. Box 8950, Wilmington,
Delaware 19899. All exchanges will be effected based on the relative net asset
values per share next determined after the exchange order is received at
PaineWebber's New York City offices or by the Transfer Agent. See 'Valuation of
Shares.' Shares of the Fund purchased through PaineWebber or its correspondent
firms may be exchanged only after the settlement date has passed and payment for
such shares has been made.
OTHER EXCHANGE INFORMATION. This exchange privilege may be modified or
terminated at any time, upon at least 60 days' notice when such notice is
required by SEC rules. See the Statement of Additional Information for further
details. This exchange privilege is available only in those jurisdictions where
the sale of the PaineWebber mutual fund shares to be acquired may be legally
made. Before making any exchange, shareholders should contact their PaineWebber
investment executives or correspondent firms or the Transfer Agent to obtain
more information and prospectuses of the PaineWebber mutual funds to be acquired
through the exchange.
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REDEMPTIONS
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Fund shares may be redeemed at their net asset value (subject to any applicable
contingent deferred sales charge) and redemption proceeds will be paid after
receipt of a redemption request as described below. PaineWebber clients may
redeem shares through PaineWebber or its correspondent firms; all other
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PaineWebber Strategic Income Fund
shareholders must redeem through the Transfer Agent. If a redeeming shareholder
owns shares of more than one Class, the shares will be redeemed in the following
order unless the shareholder specifically requests otherwise: Class A shares,
then Class C shares, and finally Class B shares.
REDEMPTION THROUGH PAINEWEBBER OR CORRESPONDENT FIRMS. PaineWebber clients may
submit redemption requests to their investment executives or correspondent firms
in person or by telephone, mail or wire. As the Fund's agent, PaineWebber may
honor a redemption request by repurchasing Fund shares from a redeeming
shareholder at the shares' net asset value next determined after receipt of the
request by PaineWebber's New York City offices. Within three Business Days after
receipt of the request, repurchase proceeds (less any applicable contingent
deferred sales charge) will be paid by check or credited to the shareholder's
brokerage account at the election of the shareholder. PaineWebber investment
executives and correspondent firms are responsible for promptly forwarding
redemption requests to PaineWebber's New York City offices.
PaineWebber reserves the right not to honor any redemption request, in which
case PaineWebber promptly will forward the request to the Transfer Agent for
treatment as described below.
REDEMPTION THROUGH THE TRANSFER AGENT. Fund shareholders who are not
PaineWebber clients must redeem their shares through the Transfer Agent by mail;
other shareholders also may redeem Fund shares through the Transfer Agent.
Shareholders should mail redemption requests directly to the Transfer Agent:
PFPC Inc., Attn: PaineWebber Mutual Funds, P.O. Box 8950, Wilmington, Delaware
19899. A redemption request will be executed at the net asset value next
computed after it is received in 'good order,' and redemption proceeds will be
paid within seven days of the receipt of the request. 'Good order' means that
the request must be accompanied by the following: (1) a letter of instruction or
a stock assignment specifying number of shares or amount of investment to be
redeemed (or that all shares credited to the Fund account be redeemed), signed
by all registered owners of the shares in the exact names in which they are
registered, (2) a guarantee of the signature of each registered owner by an
eligible institution acceptable to the Transfer Agent and in accordance with SEC
rules, such as a commercial bank, trust company or member of a recognized stock
exchange and (3) other supporting legal documents for estates, trusts,
guardianships, custodianships, partnerships and corporations. Shareholders are
responsible for ensuring that a request for redemption is received in 'good
order.'
ADDITIONAL INFORMATION ON REDEMPTIONS. Redemption proceeds of $1 million or
more may be wired to the shareholder's PaineWebber brokerage account or a
commercial bank account designated by the shareholder. Questions about this
option, or redemption requirements generally, should be referred to the
shareholder's PaineWebber investment executive or correspondent firm, or to the
Transfer Agent if the shares are not held in a PaineWebber brokerage account. If
a shareholder requests redemption of shares that were purchased recently, the
Fund may delay payment until it is assured that good payment has been received.
In the case of purchases by check, this can take up to 15 days.
Because the Fund incurs certain fixed costs in maintaining shareholder accounts,
the Fund reserves the right to redeem all Fund shares in any shareholder account
of less than $500 net asset value. If the Fund elects to do so, it will notify
the shareholder and provide the shareholder the opportunity to increase the
amount invested to $500 or more within 60 days of the notice. The Fund will not
redeem accounts that fall below $500 solely as a result of a reduction in net
asset value per share.
Shareholders who have redeemed Class A shares may reinstate their Fund account
without a sales charge up to the dollar amount redeemed by purchasing Class A
shares within 365 days after the redemption. To take advantage of this
reinstatement privilege, shareholders must notify their PaineWebber investment
executive or correspondent firm at the time the privilege is exercised.
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CONVERSION OF CLASS B SHARES
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A shareholder's Class B shares will automatically convert to Class A shares
approximately six years after the date of issuance, together with a pro rata
portion of all Class B shares representing distributions paid in additional
Class B shares. The Class B shares so converted will no longer be subject to the
higher expenses borne by Class B
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PaineWebber Strategic Income Fund
shares. The conversion will be effected at the relative net asset values per
share of the two Classes on the first Business Day of the month in which the
sixth anniversary of the issuance of the Class B shares occurs. See 'Valuation
of Shares.' If a shareholder effects one or more exchanges among Class B shares
of the PaineWebber mutual funds during the six-year period the holding periods
for the shares so exchanged will be counted toward the six-year period.
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OTHER SERVICES AND INFORMATION
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Investors interested in the services described below should consult their
PaineWebber investment executives or correspondent firms or call the Transfer
Agent toll-free at 1-800-647-1568.
AUTOMATIC INVESTMENT PLAN. Shareholders may purchase shares of the Fund through
an automatic investment plan, under which an amount specified by the shareholder
of $50 or more each month will be sent to the Transfer Agent from the
shareholder's bank for investment in the Fund. In addition to providing a
convenient and disciplined manner of investing, participation in the automatic
investment plan enables the investor to use the technique of 'dollar cost
averaging.' When under the plan a shareholder invests the same dollar amount
each month, the shareholder will purchase more shares when the Fund's net asset
value per share is low and fewer shares when the net asset value per share is
high. Using this technique, a shareholder's average purchase price per share
over any given period will be lower than if the shareholder purchased a fixed
number of shares on a monthly basis during the period. Of course, investing
through the automatic investment plan does not assure a profit or protect
against loss in declining markets. Additionally, since the automatic investment
plan involves continuous investing regardless of price levels, an investor
should consider his or her financial ability to continue purchases through the
periods of low price levels.
SYSTEMATIC WITHDRAWAL PLAN. Shareholders who own Class A or Class C shares with
a value of $5,000 or more or Class B shares with a value of $20,000 or more may
have PaineWebber redeem a portion of their shares monthly, quarterly or
semi-annually under the systematic withdrawal plan. Shareholders who participate
in the systematic withdrawal plan must elect to have all dividends reinvested in
additional shares of the same Class. The minimum amount for all withdrawals of
Class A or Class C shares is $100, and minimum monthly, quarterly and
semi-annual withdrawal amounts for Class B shares are $200, $400 and $600,
respectively. Quarterly withdrawals are made in March, June, September and
December. Provided that the shareholder does not withdraw an amount exceeding
12% (in the first year after purchase for Class A and Class C shares, annually
for Class B shares) of his or her 'Initial Account Balance,' a term that means
the value of the Fund account at the time the shareholder elects to participate
in the systematic withdrawal plan, no contingent deferred sales charge is
imposed on such withdrawals. A shareholder's participation in the systematic
withdrawal plan will terminate automatically if the Initial Account Balance
(plus the net asset value on the date of purchase of Fund shares acquired after
the election to participate in the systematic withdrawal plan), less aggregate
redemptions made other than pursuant to the systematic withdrawal plan, is less
than $5,000 for Class A and Class C shareholders or $20,000 for Class B
shareholders. Purchases of additional shares of the Fund concurrent with
withdrawals are ordinarily disadvantageous to shareholders because of tax
liabilities and, for Class A shares, sales charges.
INDIVIDUAL RETIREMENT ACCOUNTS. Shares of the Fund may be purchased through
IRAs available through the Fund. In addition, a Self-Directed IRA is available
through PaineWebber under which investments may be made in the Fund as well as
in other investments available through PaineWebber. Investors considering
establishing an IRA should review applicable tax laws and should consult their
tax advisers.
TRANSFER OF ACCOUNTS. If a shareholder holding shares of the Fund in a
PaineWebber brokerage account transfers his or her brokerage account to another
firm, the Fund shares normally will be transferred to an account with the
Transfer Agent. However, if the other firm has entered into a selected dealer
agreement with Mitchell Hutchins relating to the Fund, the shareholder may be
able to hold Fund shares in an account with the other firm.
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PaineWebber Strategic Income Fund
DIVIDENDS AND TAXES
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DIVIDENDS. Dividends from the Fund's net investment income are declared and
paid monthly. In addition, the Fund may (but is not required to) distribute with
its monthly dividends all or a portion of any net realized gains from foreign
currency transactions and net short-term capital gain, if any. The Fund
distributes annually substantially all of its net capital gain (the excess of
net long-term capital gain over net short-term capital loss) and any
undistributed net realized gains from foreign currency transactions and net
short-term capital gains. The Fund may make additional distributions if
necessary to avoid a 4% excise tax on certain undistributed income and capital
gain.
The Fund anticipates that a monthly dividend may, from time to time, represent
more or less than the amount of net investment income earned by the Fund in the
period to which the dividend relates. Any undistributed net investment income,
net short-term capital gain and net realized gains from foreign currency
transactions ('undistributed income') would be available to supplement future
dividends, which might otherwise have been reduced by reason of a decrease in
the Fund's monthly net income. Undistributed income will be reflected in the
Fund's net asset value, and correspondingly, distributions from undistributed
income will reduce the Fund's net asset value. The dividend rate on Fund shares
will be adjusted from time to time and will vary as a result of the performance
of the Fund.
If the Fund's dividends exceed its taxable income in any year, which may result
from currency-related losses, all or a portion of those dividends may be treated
as a return of capital to shareholders for tax purposes.
Dividends and other distributions paid on all Classes of Fund shares are
calculated at the same time and in the same manner. Dividends on Class B and
Class C shares of the Fund are expected to be lower than those on its Class A
shares because of the higher expenses resulting from distribution fees borne by
the Class B and Class C shares. For the same reason, dividends on Class B shares
are expected to be lower than those on Class C shares. Dividends on each Class
also might be affected differently by the allocation of Class-specific expenses.
See 'Valuation of Shares.'
Dividends and other distributions are paid in additional Fund shares of the same
Class at net asset value unless the shareholder has requested cash payments.
Shareholders who wish to receive dividends and/or other distributions in cash,
either mailed to the shareholder by check or credited to the shareholder's
PaineWebber account, should contact their PaineWebber investment executives or
correspondent firms or complete the appropriate section of the application form.
TAXES. The Fund intends to continue to qualify for treatment as a regulated
investment company under the Code so that it will be relieved of federal income
tax on that part of its investment company taxable income (consisting generally
of net investment income, net short-term capital gain and net gains from certain
foreign currency transactions) and net capital gain that is distributed to its
shareholders.
Dividends from the Fund's investment company taxable income (whether paid in
cash or in additional shares) generally are taxable to its shareholders as
ordinary income. Distributions of the Fund's net capital gain (whether paid in
cash or in additional shares) are taxable to its shareholders as long-term
capital gain, regardless of how long they have held their Fund shares.
Shareholders not subject to tax on their income generally will not be required
to pay tax on amounts distributed to them.
The Fund notifies its shareholders following the end of each calendar year of
the amounts of dividends and capital gain distributions paid (or deemed paid)
that year.
The Fund is required to withhold 31% of all dividends, capital gain
distributions and redemption proceeds payable to any individuals and certain
other noncorporate shareholders who do not provide the Fund with a correct
taxpayer identification number. Withholding at that rate also is required from
dividends and capital gain distributions payable to such shareholders who
otherwise are subject to backup withholding.
A redemption of Fund shares may result in taxable gain or loss to the redeeming
shareholder, depending upon whether the redemption proceeds payable to the
shareholder are more or less than the shareholder's adjusted basis for the
redeemed shares (which normally includes any initial sales charge paid on Class
A shares). An exchange of Fund shares for shares of another
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PaineWebber Strategic Income Fund
PaineWebber mutual fund generally will have similar tax consequences. However,
special tax rules apply when a shareholder (1) disposes of Class A shares
through a redemption or exchange within 90 days of purchase and (2) subsequently
acquires Class A shares of a PaineWebber mutual fund without paying a sales
charge due to the 365-day reinstatement privilege or exchange privilege. In
these cases, any gain on the disposition of the Fund's Class A shares would be
increased, or loss decreased, by the amount of the sales charge paid when the
shares were acquired, and that amount will increase the basis of the PaineWebber
mutual fund shares subsequently acquired. In addition, if shares of the Fund are
purchased within 30 days before or after redeeming other Fund shares (regardless
of Class) at a loss, that loss will not be deductible to the extent the
redemption proceeds are reinvested and instead will increase the basis of the
newly purchased shares.
No gain or loss will be recognized by a shareholder as a result of a conversion
of Class B shares into Class A shares.
For federal income tax purposes, the amount of any contingent deferred sales
charge paid by a redeeming shareholder will reduce the gain or increase the
loss, as the case may be, realized on the redemption.
The foregoing is only a summary of some of the important federal tax
considerations generally affecting the Fund and its shareholders; see the
Statement of Additional Information for a further discussion. There may be other
federal, state or local tax considerations applicable to a particular investor.
Prospective shareholders are therefore urged to consult their tax advisers.
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VALUATION OF SHARES
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The net asset value of the Fund's shares fluctuates and is determined separately
for each Class as of the close of regular trading on the NYSE (currently 4:00
p.m., Eastern time) each Business Day. The Fund's net asset value per share is
determined by dividing the value of the securities held by the Fund plus any
cash or other assets minus all liabilities by the total number of Fund shares
outstanding.
The Fund values its assets based on their current market value when market
quotations are readily available. If such value cannot be established, assets
are valued at fair value as determined in good faith by or under the direction
of the Trust's board of trustees. The amortized cost method of valuation
generally is used to value debt obligations with 60 days or less remaining to
maturity, unless the board of trustees determines that this does not represent
fair value. All investments denominated in foreign currencies are valued daily
in U.S. dollars based on the then-prevailing exchange rate. It should be
recognized that judgment plays a greater role in valuing foreign or high yield,
high risk securities because there is less reliable, objective data available.
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MANAGEMENT
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The Trust's board of trustees, as part of its overall management responsibility,
oversees various organizations responsible for the Fund's day-to-day management.
Mitchell Hutchins, investment adviser and administrator of the Fund, makes and
implements all investment decisions and supervises all aspects of the Fund's
operations. Mitchell Hutchins receives a monthly fee for these services at the
annual rate of 0.75% of the average daily net assets of the Fund. The Fund's
advisory fee is higher than those paid by most funds, but Mitchell Hutchins and
the board believe the fee is justified by the global nature of the Fund's
investment activities. Brokerage transactions for the Fund may be conducted
through PaineWebber in accordance with procedures adopted by the Trust's board
of trustees.
The Fund also pays PaineWebber an annual fee of $4.00 per active shareholder
account held at PaineWebber for
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PaineWebber Strategic Income Fund
certain services not provided by the Transfer Agent. The Fund also incurs other
expenses in its operations, and, for the fiscal year ended January 31, 1996,
total expenses for the Fund's Class A shares, Class B shares and Class C shares,
stated as a percentage of average net assets, were 1.74%, 2.49% and 2.24%,
respectively.
Mitchell Hutchins is located at 1285 Avenue of the Americas, New York, New York
10019. It is a wholly owned subsidiary of PaineWebber, which is in turn wholly
owned by Paine Webber Group Inc., a publicly owned financial services holding
company. As of April 30, 1996, Mitchell Hutchins was adviser or sub-adviser of
31 investment companies with 65 separate portfolios and aggregate assets of over
$30.1 billion.
Dennis McCauley, a managing director and chief investment officer of fixed
income of Mitchell Hutchins, has been the Fund's allocation manager since March
1995. Mr. McCauley has been employed by Mitchell Hutchins since December 1994
and is responsible for overseeing all active fixed income investments, including
domestic and global taxable and tax-exempt mutual funds. Prior to joining
Mitchell Hutchins, Mr. McCauley worked for IBM Corporation, where he was
director of fixed income investments responsible for developing and managing
investment strategy for all fixed income and cash management investments of
IBM's pension fund and self-insured medical funds. Mr. McCauley also served as
vice president of IBM Credit Corporation's mutual funds and as a member of the
Retirement Fund Investment Committee.
Nirmal Singh and Craig M. Varrelman, CFA, have been responsible for the
day-to-day management of the U.S. Government and Investment Grade Securities
sector of the Fund since December 1994. Mr. Singh and Mr. Varrelman are both
first vice presidents of Mitchell Hutchins. Prior to joining Mitchell Hutchins
in September 1993, Mr. Singh was with Merrill Lynch Asset Management, Inc.,
where he was a member of the portfolio management team. From 1990 to 1993, Mr.
Singh was a senior portfolio manager at Nomura Mortgage Fund Management
Corporation. Mr. Varrelman has been with Mitchell Hutchins as a portfolio
manager since 1988.
Thomas J. Libassi, a senior vice president of Mitchell Hutchins, is the sector
manager responsible for the day-to-day management of the Fund's U.S. High Yield
Securities. Mr. Libassi has been employed by Mitchell Hutchins since May 1994.
Prior to May 1994, Mr. Libassi was a vice president and portfolio manager of
Keystone Custodian Funds Inc., with portfolio management responsibility for
approximately $900 million in assets primarily invested in high yield debt
securities.
Stuart Waugh, a managing director of Mitchell Hutchins responsible for global
fixed income and currency trading, is the sector manager responsible for the
day-to-day management of the Fund's Foreign and Emerging Market Securities. Mr.
Waugh has been employed by Mitchell Hutchins since 1984.
Mitchell Hutchins investment personnel may engage in securities transactions for
their own accounts pursuant to a code of ethics that establishes procedures for
personal investing and restricts certain transactions.
DISTRIBUTION ARRANGEMENTS. Mitchell Hutchins is the distributor of the Fund's
shares and has appointed PaineWebber as the exclusive dealer for the sale of
those shares. Under separate plans of distribution pertaining to the Class A
shares, Class B shares and Class C shares ('Class A Plan,' 'Class B Plan' and
'Class C Plan,' collectively, 'Plans'), the Fund pays Mitchell Hutchins monthly
service fees at the annual rate of 0.25% of the average daily net assets of each
Class of shares and monthly distribution fees at the annual rate of 0.75% of the
average daily net assets of the Class B shares and 0.50% of the average daily
net assets of the Class C shares.
Under all three Plans, Mitchell Hutchins uses the service fees primarily to pay
PaineWebber for shareholder servicing, currently at the annual rate of 0.25% of
the aggregate investment amounts maintained in the Fund by PaineWebber clients.
PaineWebber passes on a portion of these fees to its investment executives to
compensate them for shareholder servicing that they perform and retains the
remainder to offset its own expenses in servicing and maintaining shareholder
accounts. These expenses may include costs of the PaineWebber branch office in
which the investment executive is based, such as rent, communications equipment,
employee salaries and other overhead costs.
Mitchell Hutchins uses the distribution fees under the Class B and Class C Plans
to offset the commissions it pays to PaineWebber for selling the Fund's Class B
and Class C shares. PaineWebber passes on to its investment executives a portion
of these commissions and retains the remainder to offset its expenses in selling
Class B and Class C shares. These expenses may include the branch office costs
noted above.
In addition, Mitchell Hutchins uses the distribution fees under the Class B and
Class C Plans to offset the Fund's marketing costs attributable to such Classes,
such as preparation of sales literature, advertising and printing
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Prospectus Page 28
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PaineWebber Strategic Income Fund
and distributing prospectuses and other shareholder materials to prospective
investors. Mitchell Hutchins also may use the distribution fees to pay
additional compensation to PaineWebber and other costs allocated to Mitchell
Hutchins' and PaineWebber's distribution activities, including employee
salaries, bonuses and other overhead expenses.
Mitchell Hutchins expects that, from time to time, PaineWebber will pay
shareholder servicing fees and sales commissions to its investment executives at
the time of sale of Class C shares of the Fund. If PaineWebber makes such
payments, it will retain the service and distribution fees on Class C shares
until it has been reimbursed and thereafter will pass a portion of the service
and distribution fees on Class C shares on to its investment executives.
Mitchell Hutchins receives the proceeds of the initial sales charge paid upon
the purchase of Class A shares and the contingent deferred sales charge paid
upon certain redemptions of shares, and may use these proceeds for any of the
distribution expenses described above. See 'Purchases.'
During the period they are in effect, the Plans and related distribution
contracts pertaining to each Class of shares ('Distribution Contracts') obligate
the Fund to pay service and distribution fees to Mitchell Hutchins as
compensation for its service and distribution activities, not as reimbursement
for specific expenses incurred. Thus, even if Mitchell Hutchins' expenses exceed
its service or distribution fees for the Fund, it will not be obligated to pay
more than those fees and, if Mitchell Hutchins' expenses are less than such
fees, it will retain its full fees and realize a profit. The Fund will pay the
service and distribution fees to Mitchell Hutchins until either the applicable
Plan or Distribution Contract for the Fund is terminated or not renewed. In that
event, Mitchell Hutchins' expenses in excess of service and distribution fees
received or accrued through the termination date will be Mitchell Hutchins' sole
responsibility and not obligations of the Fund. In their annual consideration of
the continuation of the Fund's Plans, the trustees will review the Plan and
Mitchell Hutchins' corresponding expenses for each Class separately from the
Plans and corresponding expenses for the other two Classes.
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PERFORMANCE INFORMATION
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The Fund performs a standardized computation of annualized total return and may
show this return in advertisements or promotional materials. Standardized return
shows the change in value of an investment in the Fund as a steady compound
annual rate of return. Actual year-by-year returns fluctuate and may be higher
or lower than standardized return. Standardized return for the Class A shares of
the Fund reflects deduction of the Fund's maximum initial sales charge at the
time of purchase, and standardized return for the Class B shares of the Fund
reflects deduction of the applicable contingent deferred sales charge imposed on
a redemption of shares held for the period. One-, five- and ten-year periods
will be shown, unless the Class has been in existence for a shorter period.
Total return calculations assume reinvestment of dividends and other
distributions.
The Fund may use other total return presentations in conjunction with
standardized return. These may cover the same or different periods as those used
for standardized return and may include cumulative returns, average annual
rates, actual year-by-year rates or any combination thereof. Non-standardized
return does not reflect initial or contingent deferred sales charges and would
be lower if such charges were included.
The Fund also may advertise its yield. Yield reflects investment income net of
expenses over a 30-day (or one-month) period on a Fund share, expressed as an
annualized percentage of the maximum offering price per share for Class A shares
and net asset value per share for Class B shares and Class C shares at the end
of the period. Yield computations differ from other accounting methods and
therefore may differ from dividends actually paid or reported net income.
Total return information reflects past performance and does not necessarily
indicate future results. Investment return and principal values will fluctuate,
and proceeds upon redemption may be more or less than a shareholder's cost.
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PaineWebber Strategic Income Fund
GENERAL INFORMATION
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ORGANIZATION. PaineWebber Securities Trust is a Massachusetts business trust
that is registered with the SEC as an open-end management investment company.
The Trust was organized under a Declaration of Trust dated December 3, 1992. The
trustees have authority to issue an unlimited number of shares of beneficial
interest of separate series, par value $.001 per share, of the Trust. In
addition to the Fund, shares of one other series have been authorized.
The shares of beneficial interest of the Fund are divided into four Classes,
designated Class A shares, Class B shares, Class C shares and Class Y shares.
Each Class represents interests in the same assets of the Fund. The Classes
differ as follows: (1) each Class of shares has exclusive voting rights on
matters pertaining to its plan of distribution, (2) Class A shares are subject
to an initial sales charge, (3) Class B shares bear ongoing distribution fees,
are subject to a contingent deferred sales charge upon most redemptions and will
automatically convert to Class A shares approximately six years after issuance,
(4) Class C shares are not subject to an initial sales charge but are subject to
a contingent deferred sales charge if redeemed within one year of purchase, bear
ongoing distribution fees and do not convert into another Class and (5) each
Class may bear differing amounts of certain Class-specific expenses. Class Y
shares, which may be offered only to limited classes of investors, are subject
to neither an initial or contingent deferred sales charge nor ongoing service or
distribution fees.
The different sales charges and other expenses applicable to the different
classes of Fund shares may affect the performance of those classes. More
information concerning Class Y shares of the Fund may be obtained from a
PaineWebber investment executive or correspondent firm or by calling
1-800-647-1568.
The Trust does not hold annual shareholder meetings. There normally will be no
meetings of shareholders to elect trustees unless fewer than a majority of the
trustees of the Trust holding office have been elected by shareholders.
Shareholders of record holding at least two-thirds of the outstanding shares of
the Trust may remove a trustee by votes cast in person or by proxy at a meeting
called for that purpose. The trustees are required to call a meeting of
shareholders for the purpose of voting upon the question of removal of any
trustee when so requested in writing by shareholders of record holding at least
10% of the Trust's outstanding shares. Each share of the Fund has equal voting
rights, except as noted above. Each share of the Fund is entitled to participate
equally in dividends and other distributions and the proceeds of any
liquidation, except that, due to the differing expenses borne by the four
Classes, such dividends and liquidation proceeds on the Class B and Class C
shares are likely to be lower than on the Class A shares and are likely to be
lower on every other Class of shares than for Class Y shares. The shares of each
series of the Trust will be voted separately except when an aggregate vote of
all series is required by the 1940 Act.
To avoid additional operating costs and for investor convenience, the Fund does
not issue share certificates. Ownership of shares of the Fund is recorded on a
stock register by the Transfer Agent and shareholders have the same rights of
ownership with respect to such shares as if certificates had been issued.
CUSTODIAN AND TRANSFER AGENT. State Street Bank and Trust Company, One Heritage
Drive, North Quincy, Massachusetts 02171 is custodian for the Fund. PFPC, Inc.,
a subsidiary of PNC Bank, National Association, whose business address is 400
Bellevue Parkway, Wilmington, Delaware 19809, is the Fund's transfer and
dividend disbursing agent.
CONFIRMATIONS AND STATEMENTS. Shareholders receive confirmations of purchases
and redemptions of shares of the Fund. PaineWebber clients receive statements at
least quarterly that report their Fund activity and consolidated year-end
statements that show all Fund transactions for that year. Shareholders who are
not PaineWebber clients receive quarterly statements from the Transfer Agent.
Shareholders also receive audited annual and unaudited semi-annual financial
statements of the Fund.
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PaineWebber Strategic Income Fund
APPENDIX A
RATINGS
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DESCRIPTION OF MOODY'S RATINGS FOR CORPORATE AND CONVERTIBLE BONDS
Aaa. Bonds which are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as 'gilt
edged.' Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa. Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other elements present which make
the long-term risk appear somewhat larger than in Aaa securities.
A. Bonds which are rated A possess many favorable investment attributes and are
to be considered as upper-medium-grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment some time in the future.
Baa. Bonds which are rated Baa are considered as medium-grade obligations
(i.e., they are neither highly protected nor poorly secured). Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba. Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B. Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa. Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca. Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
C. Bonds which are rated C are the lowest rated class of bonds, and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
DESCRIPTION OF MOODY'S PREFERRED STOCK RATINGS
aaa. An issue which is rated aaa is considered to be a top-quality preferred
stock. This rating indicates good asset protection and the least risk of
dividend impairment within the universe of preferred stocks; aa. An issue which
is rated aa is considered a high-grade preferred stock. This rating indicates
that there is reasonable assurance that earnings and asset protection will
remain relatively well-maintained in the foreseeable future; a. An issue which
is rated a is considered to be an upper-medium grade preferred stock. While
risks are judged to be somewhat greater than in the aaa and aa classifications,
earnings and asset protection are, nevertheless, expected to be maintained at
adequate levels; baa. An issue which is rated baa is considered to be medium
grade, neither highly protected nor poorly secured. Earnings and asset
protection appear adequate at present but may be questionable over any great
length of time; ba. An issue which is rated ba is considered to have speculative
elements and its future cannot be considered well assured. Earnings and asset
protection may be very moderate and not well safeguarded during adverse periods.
Uncertainty of position characterizes
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preferred stocks in this class; b. An issue which is rated b generally lacks the
characteristics of a desirable investment. Assurance of dividend payments and
maintenance of other terms of the issue over any long period of time may be
small; caa. An issue which is rated caa is likely to be in arrears on dividend
payments. This rating designation does not purport to indicate the future status
of payment; ca. An issue which is rated ca is speculative in a high degree and
is likely to be in arrears on dividends with little likelihood of eventual
payments; c. This is the lowest rated class of preferred or preference stock.
Issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Note: Moody's may apply numerical modifiers, l, 2 and 3 in each generic rating
classification from Aa/aa to B/b. The modifier l indicates that the company
ranks in the higher end of its generic rating category; the modifier 2 indicates
a mid-range ranking; and the modifier 3 indicates that the company ranks in the
lower end of its generic rating category.
DESCRIPTION OF S&P RATINGS FOR CORPORATE AND CONVERTIBLE DEBT SECURITIES
AAA. Debt rated AAA has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong.
AA. Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
A. Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB. Debt rated BBB is regarded as having adequate capacity to pay interest and
repay principal. Whereas it normally exhibits adequate protection parameters,
adverse economic conditions or changing circumstances are more likely to lead to
a weakened capacity to pay interest and repay principal for debt in this
category than in higher rated categories.
BB, B, CCC, CC, C. Debt rated BB, B, CCC, CC and C is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. BB indicates the
lowest degree of speculation and C the highest degree of speculation. While such
debt will likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major risk exposures to adverse conditions.
BB. Debt rated BB has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The BB
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied BBB- rating.
B. Debt rated B has a greater vulnerability to default but currently has the
capacity to meet interest payments and principal repayments. Adverse business,
financial, or economic conditions will likely impair capacity or willingness to
pay interest and repay principal. The B rating category is also used for debt
subordinated to senior debt that is assigned an actual or implied BB or BB-
rating.
CCC. Debt rated CCC has a currently identifiable vulnerability to default, and
is dependent upon favorable business, financial, and economic conditions to meet
timely payment of interest and repayment of principal. In the event of adverse
business, financial, or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The CCC rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
B or B- rating.
CC. The rating CC is typically applied to debt subordinated to senior debt that
is assigned an actual or implied CCC rating.
C. The rating C is typically applied to debt subordinated to senior debt which
is assigned an actual or implied CCC-debt rating. The C rating may be used to
cover a situation where a bankruptcy petition has been filed, but debt service
payments are continued.
CI. The rating CI is reserved for income bonds on which no interest is being
paid.
D. Debt rated D is in payment default. The D rating category is used when
interest payments or principal payments are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period. The D rating also will be used upon the
filing of a bankruptcy petition if debt service payments are jeopardized.
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DESCRIPTION OF S&P PREFERRED STOCK RATINGS
AAA. This is the highest rating that may be assigned by S&P to a preferred
stock issue and indicates an extremely strong capacity to pay the preferred
stock obligations; AA. A preferred stock issue rated AA also qualifies as a
high-quality fixed income security. The capacity to pay preferred stock
obligations is very strong, although not as overwhelming as for issues rated
AAA; A. An issue rated A is backed by a sound capacity to pay the preferred
stock obligations, although it is somewhat more susceptible to the adverse
effect of changes in circumstances and economic conditions; BBB. An issue rated
BBB is regarded as backed by an adequate capacity to pay the preferred stock
obligations. Whereas it normally exhibits adequate protection parameters,
adverse economic conditions or changing circumstances are more likely to lead to
a weakened capacity to make payments for a preferred stock in this category than
for issues in the A category; BBB, B, CCC. Preferred stocks rated BB, B, and CCC
are regarded, on balance, as predominantly speculative with respect to the
issuer's capacity to pay preferred stock obligations. BB indicates the lowest
degree of speculation and CCC the highest degree of speculation. While such
issues will likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major risk exposures to adverse conditions;
CC. The rating CC is reserved for a preferred stock issue in arrears on
dividends or sinking fund payments but that is currently paying; C. A preferred
stock rated C is a non-paying issue; D. A preferred stock rated D is a
non-paying issue with issuer in default on debt instruments.
NR. NR indicates that no public rating has been requested, that there is
insufficient information on which to base a rating, or that S&P does not rate a
particular type of obligation as a matter of policy.
PLUS (+) OR MINUS (--). The ratings from AA to CCC may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
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APPENDIX B
MORTGAGE-BACKED SECURITIES
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The U.S. government securities in which the Fund may invest include
mortgage-backed securities issued or guaranteed as to payment of principal and
interest (but not as to market value) by the Government National Mortgage
Association ('Ginnie Mae'), the Federal National Mortgage Association ('Fannie
Mae'), or the Federal Home Loan Mortgage Corporation ('Freddie Mac'). Other
mortgage-backed securities in which the Fund may invest are issued by private
issuers, generally originators of and investors in mortgage loans, including
savings associations, mortgage bankers, commercial banks, investment bankers and
special purpose entities (collectively, 'Private Mortgage Lenders'). Payments of
principal and interest (but not the market value) of such private
mortgage-backed securities may be supported by pools of mortgage loans or other
mortgage-backed securities that are guaranteed, directly or indirectly, by the
U.S. government or one of its agencies or instrumentalities, or they may be
issued without any government guarantee of the underlying mortgage assets but
with some form of non-government credit enhancement. New types of
mortgage-backed securities are developed and marketed from time to time and,
consistent with its investment limitations, the Fund expects to invest in those
new types of mortgage-backed securities that Mitchell Hutchins believes may
assist the Fund in achieving its investment objectives. Similarly, the Fund may
invest in mortgage-backed securities issued by new or existing governmental or
private issuers other than those identified herein.
GINNIE MAE CERTIFICATES
Ginnie Mae guarantees certain mortgage pass-through certificates ('Ginnie Mae
certificates') that are issued by Private Mortgage Lenders and that represent
ownership interests in individual pools of residential mortgage loans. These
securities are designed to provide monthly payments of interest and principal to
the investor. Timely payment of interest and principal is backed by the full
faith and credit of the U.S. government. Each mortgagor's monthly payments to
his lending institution on his residential mortgage are 'passed through' to
certificateholders such as the Fund. Mortgage pools consist of whole mortgage
loans or participations in loans. The terms and characteristics of the mortgage
instruments are generally uniform within a pool but may vary among pools.
Lending institutions that originate mortgages for the pools are subject to
certain standards, including credit and other underwriting criteria for
individual mortgages included in the pools.
FANNIE MAE CERTIFICATES
Fannie Mae facilitates a national secondary market in residential mortgage loans
insured or guaranteed by U.S. government agencies and in privately insured or
uninsured residential mortgage loans (sometimes referred to as 'conventional
mortgage loans' or 'conventional loans') through its mortgage purchase and
mortgage-backed securities sales activities. Fannie Mae issues guaranteed
mortgage pass-through certificates ('Fannie Mae certificates'), which represent
pro rata shares of all interest and principal payments made and owed on the
underlying pools. Fannie Mae guarantees timely payment of interest and principal
on Fannie Mae certificates. The Fannie Mae guarantee is not backed by the full
faith and credit of the U.S. government.
FREDDIE MAC CERTIFICATES
Freddie Mac also facilitates a national secondary market for conventional
residential and U.S. government-insured mortgage loans through its mortgage
purchase and mortgage-backed securities sales activities. Freddie Mac issues two
types of mortgage pass-through securities: mortgage participation certificates
('PCs') and guaranteed mortgage certificates ('GMCs'). Each PC represents a pro
rata share of all interest and principal payments made and owed on the
underlying pool. Freddie Mac generally guarantees timely monthly payment of
interest on PCs and the ultimate payment of principal, but it also has a PC
program under which it guarantees timely payment of both principal and interest.
GMCs also represent a pro rata interest in a pool of mortgages. These
instruments, however, pay interest semi-annually and return
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principal once a year in guaranteed minimum payments. The Freddie Mac guarantee
is not backed by the full faith and credit of the U.S. government.
PRIVATE, RTC AND SIMILAR MORTGAGE-BACKED SECURITIES
Mortgage-backed securities issued by Private Mortgage Lenders are structured
similarly to the pass-through certificates and collateralized mortgage
obligations ('CMOs') issued or guaranteed by Ginnie Mae, Fannie Mae and Freddie
Mac. Such mortgage-backed securities may be supported by pools of U.S.
government or agency insured or guaranteed mortgage loans or by other
mortgage-backed securities issued by a government agency or instrumentality, but
they generally are supported by pools of conventional (i.e., non-government
guaranteed or insured) mortgage loans. Since such mortgage-backed securities
normally are not guaranteed by an entity having the credit standing of Ginnie
Mae, Fannie Mae or Freddie Mac, they normally are structured with one or more
types of credit enhancement. See '--Types of Credit Enhancement.'
The Resolution Trust Corporation ('RTC'), which was organized by the U.S.
government in connection with the savings and loan crisis, held assets of failed
savings associations as either a conservator or receiver for such associations,
or it acquired such assets in its corporate capacity. These assets included
among other things, single family and multifamily mortgage loans, as well as
commercial mortgage loans. In order to dispose of such assets in an orderly
manner, RTC established a vehicle registered with the SEC through which it sold
mortgage-backed securities. RTC mortgage-backed securities represent pro rata
interests in pools of mortgage loans that RTC held or had acquired, as described
above, and are supported by one or more of the types of private credit
enhancements used by Private Mortgage Lenders.
COLLATERALIZED MORTGAGE OBLIGATIONS AND MULTI-CLASS MORTGAGE PASS-THROUGHS
CMOs are debt obligations that are collateralized either by mortgage loans or
mortgage pass-through securities (such collateral collectively being called
'Mortgage Assets'). CMOs may be issued by Private Mortgage Lenders or by
government entities such as Fannie Mae or Freddie Mac. Multi-class mortgage
pass-through securities are interests in trusts that are comprised of Mortgage
Assets and that have multiple classes similar to those in CMOs. Unless the
context indicates otherwise, references herein to CMOs include multi-class
mortgage pass-through securities. Payments of principal and interest on the
Mortgage Assets (and, in the case of CMOs, any reinvestment income thereon)
provide the funds to pay debt service on the CMOs or to make scheduled
distributions on the multi-class mortgage pass-through securities.
In a CMO, a series of bonds or certificates is issued in multiple classes. Each
class of CMO, also referred to as a 'tranche,' is issued at a specific fixed or
floating coupon rate and has a stated maturity or final distribution date.
Principal prepayments on the Mortgage Assets may cause CMOs to be retired
substantially earlier than their stated maturities or final distribution dates.
Interest is paid or accrues on all classes of a CMO (other than any principal
only ('PO') class) on a monthly, quarterly or semiannual basis. The principal
and interest on the Mortgage Assets may be allocated among the several classes
of a CMO in many ways. In one structure, payments of principal, including any
principal prepayments, on the Mortgage Assets are applied to the classes of a
CMO in the order of their respective stated maturities or final distribution
dates so that no payment of principal will be made on any class of the CMO until
all other classes having an earlier stated maturity or final distribution date
have been paid in full. In some CMO structures, all or a portion of the interest
attributable to one or more of the CMO classes may be added to the principal
amounts attributable to such classes, rather than passed through to
certificateholders on a current basis, until other classes of the CMO are paid
in full.
Parallel pay CMOs are structured to provide payments of principal on each
payment date to more than one class. These simultaneous payments are taken into
account in calculating the stated maturity date or final distribution date of
each class, which, as with other CMO structures, must be retired by its stated
maturity date or final distribution date but may be retired earlier.
ARM AND FLOATING RATE MORTGAGE-BACKED SECURITIES
ARM mortgage-backed securities are mortgage-backed securities that represent a
right to receive interest payments at a rate that is adjusted to reflect the
interest earned on a pool of mortgage loans bearing variable or adjustable rates
of interest (such mortgage loans are referred to as 'ARMs'). Floating rate
mortgage-backed securities are classes of mortgage-backed securities that have
been structured to represent the right to receive interest payments at rates
that fluctuate in accordance with an index but that generally are supported by
pools comprised of fixed-rate mortgage loans. Because the interest rates
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on ARM and floating rate mortgage-backed securities are reset in response to
changes in a specified market index, the values of such securities tend to be
less sensitive to interest rate fluctuations than the values of fixed-rate
securities.
TYPES OF CREDIT ENHANCEMENT
To lessen the effect of failures by obligors on Mortgage Assets to make
payments, mortgage-backed securities may contain elements of credit enhancement.
Such credit enhancement falls into two categories; (1) liquidity protection and
(2) protection against losses resulting after default by an obligor on the
underlying assets and collection of all amounts recoverable directly from the
obligor and through liquidation of the collateral. Liquidity protection refers
to the provision of advances, generally by the entity administering the pool of
assets (usually the bank, savings association or mortgage banker that
transferred the underlying loans to the issuer of the security), to ensure that
the receipt of payments on the underlying pool occurs in a timely fashion.
Protection against losses resulting after default and liquidation ensures
ultimate payment of the obligations on at least a portion of the assets in the
pool. Such protection may be provided through guarantees, insurance policies or
letters of credit obtained by the issuer or sponsor, from third parties, through
various means of structuring the transaction or through a combination of such
approaches. The Fund will not pay any additional fees for such credit
enhancement, although the existence of credit enhancement may increase the price
of a security. Credit enhancements do not provide protection against changes in
the market value of the security.
Examples of credit enhancement arising out of the structure of the transaction
include 'senior-subordinated securities' (multiple class securities with one or
more classes subordinate to other classes as to the payment of principal thereof
and interest thereon, with the result that defaults on the underlying assets are
borne first by the holders of the subordinated class), creation of 'spread
accounts' or 'reserve funds' (where cash or investments, sometimes funded from a
portion of the payments on the underlying assets, are held in reserve against
future losses) and 'over-collateralization' (where the scheduled payments on, or
the principal amount of, the underlying assets exceed that required to make
payment of the securities and pay any servicing or other fees). The degree of
credit enhancement provided for each issue generally is based on historical
information regarding the level of credit risk associated with the underlying
assets. Delinquency or loss in excess of that anticipated could adversely affect
the return on an investment in such a security.
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APPENDIX C
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The Fund may use the following Hedging Instruments:
OPTIONS ON DEBT SECURITIES AND CURRENCIES--A call option is a contract pursuant
to which the purchaser of the option, in return for a premium, has the right to
buy the security or currency underlying the option at a specified price at any
time during the term, or upon the expiration, of the option. The writer of a
call option, who receives the premium, has the obligation, upon exercise of the
option, to deliver the underlying security or currency against payment of the
exercise price. A put option is a similar contract that gives its purchaser, in
return for a premium, the right to sell the underlying security or currency at a
specified price during the option term or upon expiration. The writer of a put
option, who receives the premium, has the obligation, upon exercise, to buy the
underlying security or currency at the exercise price.
OPTIONS ON INDICES OF DEBT SECURITIES--An index assigns relative values to the
securities included in the index and fluctuates with changes in the market
values of such securities. Index options operate in the same way as more
traditional options except that exercises of index options are effected with
cash payment and do not involve delivery of securities. Thus, upon exercise of
an index option, the purchaser will realize, and the writer will pay, an amount
based on the difference between the exercise price and the closing price of the
index.
DEBT AND EQUITY SECURITY INDEX FUTURES CONTRACTS--An index futures contract is a
bilateral agreement pursuant to which one party agrees to accept and the other
party agrees to make delivery of an amount of cash equal to a specified dollar
amount times the difference between the index value at the close of trading of
the contract and the price at which the futures contract is originally struck.
No physical delivery of the securities comprising the index is made; generally,
contracts are closed out prior to the expiration date of the contract.
DEBT SECURITY AND CURRENCY FUTURES CONTRACTS--A debt security or currency
futures contract is a bilateral agreement pursuant to which one party agrees to
accept and the other party agrees to make delivery of the specific type of debt
security or currency called for in the contract at a specified future time and
at a specified price.
OPTIONS ON FUTURES CONTRACTS--Options on futures contracts are similar to
options on securities or currency, except that an option on a futures contract
gives the purchaser the right, in return for the premium, to assume a position
in a futures contract (a long position if the option is a call and a short
position if the option is a put), rather than to purchase or sell a security or
currency, at a specified price at any time during the option term. Upon exercise
of the option, the delivery of the futures position to the holder of the option
will be accomplished by delivery of the accumulated balance that represents the
amount by which the market price of the futures contract exceeds, in the case of
a call, or is less than, in the case of a put, the exercise price of the option
on the future. The writer of an option, upon exercise, will assume a short
position in the case of a call and a long position in the case of a put.
FORWARD CURRENCY CONTRACTS--A forward currency contract involves an obligation
to purchase or sell a specific currency at a specified future date, which may be
any fixed number of days from the contract date agreed upon by the parties, at a
price set at the time the contract is entered into.
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Shares of the Fund can be exchanged for shares of the following PaineWebber
Mutual Funds:
INCOME FUNDS
o Global Income Fund
o High Income Fund
o Investment Grade Income Fund
o Low Duration U.S. Government Income Fund
o U.S. Government Income Fund
TAX-FREE INCOME FUNDS
o California Tax-Free Income Fund
o Municipal High Income Fund
o National Tax-Free Income Fund
o New York Tax-Free Income Fund
GROWTH FUNDS
o Capital Appreciation Fund
o Emerging Markets Equity Fund
o Financial Services Growth Fund
o Global Equity Fund
o Growth Fund
o Small Cap Growth Fund
o Small Cap Value Fund
GROWTH AND INCOME FUNDS
o Balanced Fund
o Growth and Income Fund
o Tactical Allocation Fund
o Utility Income Fund
PAINEWEBBER MONEY MARKET FUND
------------------------
A prospectus containing more complete information for any of the above funds,
including charges and expenses, can be obtained from a PaineWebber investment
executive or correspondent firm. Read it carefully before investing.
(Copyright)1996 PaineWebber Incorporated
PaineWebber
Strategic Income
Fund
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NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR MAKE ANY
REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN CONNECTION WITH THE
OFFERING MADE BY THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR
REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE
FUND OR ITS DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFERING BY
THE FUND OR ITS DISTRIBUTOR IN ANY JURISDICTION IN WHICH SUCH OFFERING MAY
NOT LAWFULLY BE MADE.
PROSPECTUS
June 3, 1996
<PAGE>
PAINEWEBBER STRATEGIC INCOME FUND
1285 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019
STATEMENT OF ADDITIONAL INFORMATION
PaineWebber Strategic Income Fund ('Fund') is a non-diversified series of
PaineWebber Securities Trust ('Trust'), a professionally managed, open-end
investment company organized as a Massachusetts business trust. The Fund's
primary investment objective is to achieve a high level of current income and,
secondarily, capital appreciation. The Fund seeks to achieve its investment
objectives by investing in a portfolio of fixed income securities (including
debt instruments the payment on which may be fixed, variable or floating and
also zero coupon securities that pay no interest until maturity) that is
strategically allocated among U.S. Government and Investment Grade Securities,
U.S. High Yield Securities and Foreign and Emerging Market Securities. The
Fund's investment adviser, administrator and distributor is Mitchell Hutchins
Asset Management Inc. ('Mitchell Hutchins'), a wholly owned subsidiary of
PaineWebber Incorporated ('PaineWebber'). As distributor for the Fund, Mitchell
Hutchins has appointed PaineWebber to serve as the exclusive dealer for the sale
of Fund shares. This Statement of Additional Information is not a prospectus and
should be read only in conjunction with the Fund's current Prospectus, dated
June 3, 1996. All capitalized terms not otherwise defined herein have the same
meanings as in the Prospectus. A copy of the Prospectus may be obtained by
calling any PaineWebber investment executive or correspondent firm or by calling
toll-free 1-800-647-1568. This Statement of Additional Information is dated June
3, 1996.
INVESTMENT POLICIES AND RESTRICTIONS
The following supplements the information contained in the Prospectus
concerning the Fund's investment policies and limitations.
SPECIAL CHARACTERISTICS OF MORTGAGE- AND ASSET-BACKED SECURITIES
The yield characteristics of mortgage- and asset-backed securities differ
from those of traditional debt securities. Among the major differences are that
interest and principal payments are made more frequently, usually monthly, and
that principal may be prepaid at any time because the underlying mortgage loans
or other obligations generally may be prepaid at any time. Prepayments on a pool
of mortgage loans are influenced by a variety of economic, geographic, social,
and other factors, including changes in mortgagors' housing needs, job
transfers, unemployment, mortgagors' net equity in the mortgaged properties and
servicing decisions. Generally, however, prepayments on fixed-rate mortgage
loans will increase during a period of falling interest rates and decrease
during a period of rising interest rates. Similar factors apply to prepayments
on asset-backed securities, but the receivables underlying asset-backed
securities generally are of a shorter maturity and thus are less likely to
experience substantial prepayments. Such securities, however, often provide that
for a specified time period the issuers will replace receivables in the pool
that are repaid with comparable obligations. If the issuer is unable to do so,
repayment of principal on the asset-backed securities may commence at an earlier
date. Mortgage- and asset-backed securities may decrease in value as a result of
increases in interest rates and may benefit less than other fixed-income
securities from declining interest rates because of the risk of prepayment.
The rate of interest on mortgage-backed securities is lower than the
interest rates paid on the mortgages included in the underlying pool due to the
annual fees paid to the servicer of the mortgage pool for passing through
monthly payments to certificateholders and to any guarantor, and due to any
yield retained by the issuer. Actual yield to the holder may vary from the
coupon rate, even if adjustable, if the mortgage-backed securities are purchased
or traded in the secondary market at a premium or discount. In addition, there
is normally some delay between the time the issuer
<PAGE>
receives mortgage payments from the servicer and the time the issuer makes the
payments on the mortgage-backed securities, and this delay reduces the effective
yield to the holder of such securities.
Yields on pass-through securities are typically quoted by investment
dealers and vendors based on the maturity of the underlying instruments and the
associated average life assumption. The average life of pass-through pools
varies with the maturities of the underlying mortgage loans. A pool's term may
be shortened by unscheduled or early payments of principal on the underlying
mortgages as well as changes in interest rates. Because prepayment rates of
individual pools vary widely, it is not possible to predict accurately the
average life of a particular pool. In the past, a common industry practice has
been to assume that prepayments on pools of fixed rate 30-year mortgages would
result in a 12-year average life for the pool. At present, mortgage pools,
particularly those with loans with other maturities or different
characteristics, are priced on an assumption of average life determined for each
pool. In periods of declining interest rates, the rate of prepayment tends to
increase, thereby shortening the actual average life of a pool of
mortgage-related securities. Conversely, in periods of rising interest rates,
the rate of prepayment tends to decrease, thereby lengthening the actual average
life of the pool. However, these effects may not be present, or may differ in
degree, if the mortgage loans in the pools have adjustable interest rates or
other special payment terms, such as a prepayment charge. Actual prepayment
experience may cause the yield of mortgage-backed securities to differ from the
assumed average life yield. Reinvestment of prepayments may occur at lower
interest rates than the original investment, thus adversely affecting the yield
of the Fund.
The Fund may invest in adjustable rate mortgage ('ARM') and floating rate
mortgage-backed securities. Because the interest rates on ARM and floating rate
mortgage-backed securities are reset in response to changes in a specified
market index, the values of such securities tend to be less sensitive to
interest rate fluctuations than the values of fixed-rate securities. As a
result, during periods of rising interest rates, ARMs generally do not decrease
in value as much as fixed rate securities. Conversely, during periods of
declining rates, ARMs generally do not increase in value as much as fixed rate
securities. ARM mortgage-backed securities represent a right to receive interest
payments at a rate that is adjusted to reflect the interest earned on a pool of
ARMs. ARMs generally provide that the borrower's mortgage interest rate may not
be adjusted above a specified lifetime maximum rate or, in some cases, below a
minimum lifetime rate. In addition, certain ARMs provide for limitations on the
maximum amount by which the mortgage interest rate may adjust for any single
adjustment period. ARMs also may provide for limitations on changes in the
maximum amount by which the borrower's monthly payment may adjust for any single
adjustment period. In the event that a monthly payment is not sufficient to pay
the interest accruing on the ARM, any such excess interest is added to the
mortgage loan ('negative amortization'), which is repaid through future
payments. If the monthly payment exceeds the sum of the interest accrued at the
applicable mortgage interest rate and the principal payment that would have been
necessary to amortize the outstanding principal balance over the remaining term
of the loan, the excess reduces the principal balance of the ARM. Borrowers
under ARMs experiencing negative amortization may take longer to build up their
equity in the underlying property and may be more likely to default.
The rates of interest payable on certain ARMs, and therefore on certain ARM
mortgage-backed securities, are based on indices, such as the one-year constant
maturity Treasury rate, that reflect changes in market interest rates. Others
are based on indices, such as the 11th District Federal Home Loan Bank Cost of
Funds index ('COFI'), that tend to lag behind changes in market interest rates.
The values of ARM mortgage-backed securities supported by ARMs that adjust based
on lagging indices tend to be somewhat more sensitive to interest rate
fluctuations than those reflecting current interest rate levels, although the
values of such ARM mortgage-backed securities still tend to be less sensitive to
interest rate fluctuations than fixed-rate securities.
Floating rate mortgage-backed securities are classes of mortgage-backed
securities that have been structured to represent the right to receive interest
payments at rates that fluctuate in accordance with an index but that generally
are supported by pools comprised of fixed-rate mortgage loans. As with ARM
mortgage-backed securities, interest rate
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adjustments on floating rate mortgage-backed securities may be based on indices
that lag behind market interest rates. Interest rates on floating rate
mortgage-backed securities generally are adjusted monthly. Floating rate
mortgage-backed securities are subject to lifetime interest rate caps, but they
generally are not subject to limitations on monthly or other periodic changes in
interest rates or monthly payments.
ARMs also may be subject to a greater rate of prepayments in a declining
interest rate environment. For example, during a period of declining interest
rates, prepayments on ARMs could increase because the availability of fixed
mortgage loans at competitive interest rates may encourage mortgagors to
'lock-in' at a lower interest rate. Conversely, during a period of rising
interest rates, prepayments on ARMs might decrease. The rate of prepayments with
respect to ARMs has fluctuated in recent years.
SPECIAL CHARACTERISTICS OF FOREIGN AND EMERGING MARKET SECURITIES
EMERGING MARKET SECURITIES. Many of the Foreign and Emerging Market
Securities held by the Fund will not be registered with the SEC, nor will the
issuers thereof be subject to SEC reporting requirements. Accordingly, there may
be less publicly available information concerning foreign issuers of securities
held by the Fund than is available concerning U.S. companies. Disclosure and
regulatory standards in many respects are less stringent in emerging market
countries than in the U.S. and other major markets. There also may be a lower
level of monitoring and regulation of emerging markets and the activities of
investors in such markets, and enforcement of existing regulations may be
extremely limited. Foreign companies, and in particular, companies in smaller
and emerging capital markets are not generally subject to uniform accounting,
auditing and financial reporting standards or to other regulatory requirements
comparable to those applicable to U.S. companies. The Fund's net investment
income and capital gains from its foreign investment activities may be subject
to non-U.S. withholding taxes.
The costs attributable to foreign investing that the Fund must bear
frequently are higher than those attributable to domestic investing; this is
particularly true with respect to emerging capital markets. For example, the
cost of maintaining custody of foreign securities exceeds custodian costs for
domestic securities, and transaction and settlement costs of foreign investing
also frequently are higher than those attributable to domestic investing. Costs
associated with the exchange of currencies also make foreign investing more
expensive than domestic investing. Investment income on certain foreign
securities in which the Fund may invest may be subject to foreign withholding or
other government taxes that could reduce the return of these securities. Tax
treaties between the United States and foreign countries, however, may reduce or
eliminate the amount of foreign tax to which the Fund would be subject.
Foreign markets also have different clearance and settlement procedures,
and in certain markets there have been times when settlements have failed to
keep pace with the volume of securities transactions, making it difficult to
conduct such transactions. Delays in settlement could result in temporary
periods when assets of the Fund are uninvested and no return is earned thereon.
The inability of the Fund to make intended security purchases due to settlement
problems could cause the Fund to miss attractive investment opportunities.
Inability to dispose of a portfolio security due to settlement problems could
result either in losses to the Fund due to subsequent declines in the value of
such portfolio security or, if the Fund has entered into a contract to sell the
security, could result in possible liability to the purchaser.
SOVEREIGN DEBT. Sovereign Debt differs from debt obligations issued by
private entities in that, generally, remedies for defaults must be pursued in
the courts of the defaulting party. Legal recourse is therefore limited.
Political conditions, especially a sovereign entity's willingness to meet the
terms of its debt obligations, are of considerable significance. Also, there can
be no assurance that the holders of commercial bank loans to the same sovereign
entity may not contest payments to the holders of Sovereign Debt in the event of
default under commercial bank loan agreements.
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A sovereign debtor's willingness or ability to pay interest and repay
principal in a timely manner may be affected by, among other factors, its cash
flow situation, the extent of its foreign reserves, the availability of
sufficient foreign exchange on the date a payment is due, the relative size of
the debt service burden to the economy as a whole, the sovereign debtor's policy
toward principal international lenders and the political constraints to which a
sovereign debtor may be subject. A country whose exports are concentrated in a
few commodities could be vulnerable to a decline in the international price of
such commodities. Increased protectionism on the part of a country's trading
partners, or political changes in those countries, could also adversely affect
its exports. Such events could diminish a country's trade account surplus, if
any, or the credit standing of a particular local government or agency. Another
factor bearing on the ability of a country to repay Sovereign Debt is the level
of the country's international reserves. Fluctuations in the level of these
reserves can affect the amount of foreign exchange readily available for
external debt payments and, thus, could have a bearing on the capacity of the
country to make payments on its Sovereign Debt.
To the extent that a country has a current account deficit (generally when
exports of merchandise and services are less than the country's imports of
merchandise and services plus net transfers (e.g., gifts of currency and goods)
to foreigners), it will need to depend on loans from foreign governments,
multilateral organizations or private commercial banks, aid payments from
foreign governments and inflows of foreign investment. The access of a country
to these forms of external funding may not be certain, and a withdrawal of
external funding could adversely affect the capacity of a government to make
payments on its obligations. In addition, the cost of servicing debt obligations
can be affected by a change in international interest rates since the majority
of these obligations carry interest rates that are adjusted periodically based
upon international rates.
With respect to Sovereign Debt of emerging market issuers, investors should
be aware that certain emerging market countries are among the largest debtors to
commercial banks and foreign governments. At times certain emerging market
countries have declared moratoria on the payment of principal and interest on
external debt; such moratoria are currently in effect in certain Latin American
countries.
Certain emerging market countries have experienced difficulty in servicing
their Sovereign Debt on a timely basis which led to defaults on certain
obligations and the restructuring of certain indebtedness. Restructuring
arrangements have included, among other things, reducing and rescheduling
interest and principal payments by negotiating new or amended credit agreements
or converting outstanding principal and unpaid interest to Brady Bonds
(discussed below), and obtaining new credit to finance interest payments.
Holders of Sovereign Debt, including the Fund, may be requested to participate
in the rescheduling of such debt and to extend further loans to sovereign
debtors. The interests of holders of Sovereign Debt could be adversely affected
in the course of restructuring arrangements or by certain other factors referred
to below. Furthermore, some of the participants in the secondary market for
Sovereign Debt may also be directly involved in negotiating the terms of these
arrangements and may therefore have access to information not available to other
market participants. Obligations arising from past restructuring agreements may
affect the economic performance and political and social stability of certain
issuers of Sovereign Debt. There is no bankruptcy proceeding by which Sovereign
Debt on which a sovereign has defaulted may be collected in whole or in part.
Foreign investment in certain Sovereign Debt is restricted or controlled to
varying degrees. These restrictions or controls may at times limit or preclude
foreign investment in such Sovereign Debt and increase the costs and expenses of
the Fund. Certain countries in which the Fund will invest require governmental
approval prior to investments by foreign persons, limit the amount of investment
by foreign persons in a particular issuer, limit the investment by foreign
persons only to a specific class of securities of an issuer that may have less
advantageous rights than the classes available for purchase by domiciliaries of
the countries or impose additional taxes on foreign investors. Certain issuers
may require governmental approval for the repatriation of investment income,
capital or the proceeds of sales of securities by foreign investors. In
addition, if a deterioration occurs in a country's balance of payments, the
country
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could impose temporary restrictions on foreign capital remittances. The Fund
could be adversely affected by delays in, or a refusal to grant, any required
governmental approval for repatriation of capital, as well as by the application
to the Fund of any restrictions on investments. Investing in local markets may
require the Fund to adopt special procedures, seek local government approvals or
take other actions, each of which may involve additional costs to the Fund.
BRADY BONDS. The Fund may invest in Brady Bonds and other Sovereign Debt
of countries that have restructured or are in the process of restructuring
Sovereign Debt pursuant to the Brady Plan. Brady Bonds are Sovereign Debt
securities issued under the framework of the Brady Plan, an initiative announced
by former U.S. Treasury Secretary Nicholas F. Brady in 1989 as a mechanism for
debtor nations to restructure their outstanding external commercial bank
indebtedness. In restructuring its external debt under the Brady Plan framework,
a debtor nation negotiates with its existing bank lenders as well as
multilateral institutions such as the IMF. The Brady Plan framework, as it has
developed, contemplates the exchange of commercial bank debt for newly issued
Brady Bonds. Brady Bonds may also be issued in respect of new money being
advanced by existing lenders in connection with the debt restructuring. The
World Bank and the IMF support the restructuring by providing funds pursuant to
loan agreements or other arrangements which enable the debtor nation to
collateralize the new Brady Bonds or to repurchase outstanding bank debt at a
discount.
Brady Plan debt restructurings totalling more than $80 billion have been
implemented to date in Mexico, Costa Rica, Venezuela, Uruguay, Nigeria,
Argentina and the Philippines and, in addition, Brazil has announced intentions
to issue Brady Bonds. There can be no assurance that the circumstances regarding
the issuance of Brady Bonds by these countries will not change. Investors should
recognize that Brady Bonds have been issued only recently, and accordingly do
not have a long payment history. Agreements implemented under the Brady Plan to
date are designed to achieve debt and debt-service reduction through specific
options negotiated by a debtor nation with its creditors. As a result, the
financial packages offered by each country differ. The types of options have
included the exchange of outstanding commercial bank debt for bonds issued at
100% of face value of such debt, which carry a below-market stated rate of
interest (generally known as par bonds), bonds issued at a discount from the
face value of such debt (generally known as discount bonds), bonds bearing an
interest rate which increases over time and bonds issued in exchange for the
advancement of new money by existing lenders. Regardless of the stated face
amount and stated interest rate of the various types of Brady Bonds, the Fund
will purchase Brady Bonds in secondary markets, as described below, in which the
price and yield to the investor reflect market conditions at the time of
purchase.
Certain Brady Bonds have been collateralized as to principal due at
maturity by U.S. Treasury zero coupon bonds with maturities equal to the final
maturity of such Brady Bonds. Collateral purchases are financed by the IMF, the
World Bank and the debtor nations' reserves. In the event of a default with
respect to collateralized Brady Bonds as a result of which the payment
obligations of the issuer are accelerated, the U.S. Treasury zero coupon
obligations held as collateral for the payment of principal will not be
distributed to investors, nor will such obligations be sold and the proceeds
distributed. The collateral will be held by the collateral agent to the
scheduled maturity of the defaulted Brady Bonds, which will continue to be
outstanding, at which time the face amount of the collateral will equal the
principal payments which would have then been due on the Brady Bonds in the
normal course. In addition, interest payments on certain types of Brady Bonds
may be collateralized by cash or high grade securities in amounts that typically
represent between 12 and 18 months of interest accruals on these instruments
with the balance of the interest accruals being uncollateralized. Brady Bonds
are often viewed as having several valuation components: (1) the collateralized
repayment of principal, if any, at final maturity, (2) the collateralized
interest payments, if any, (3) the uncollateralized interest payments and (4)
any uncollateralized repayment of principal at maturity (these uncollateralized
amounts constitute the 'residual risk'). In light of the residual risk of Brady
Bonds and, among other factors, the history of defaults with respect to
commercial bank loans by public and private entities of countries issuing Brady
Bonds, investments in Brady Bonds are to be viewed as speculative. The Fund may
purchase Brady
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Bonds with no or limited collateralization, and will be relying for payment of
interest and (except in the case of principal collateralized Brady Bonds)
repayment of principal primarily on the willingness and ability of the foreign
government to make payment in accordance with the terms of the Brady Bonds.
Brady Bonds issued to date are purchased and sold in secondary markets through
U.S. securities dealers and other financial institutions and are generally
maintained through European transnational securities depositories.
STRUCTURED FOREIGN INVESTMENTS. The Fund may invest a portion of its
assets in interests in U.S. and foreign entities organized and operated solely
for the purpose of securitizing or restructuring the investment characteristics
of foreign securities. This type of securitization or restructuring involves the
deposit with or purchase by a U.S. or foreign entity, such as a corporation or
trust, of specified instruments (such as commercial bank loans or Brady Bonds)
and the issuance by that entity of one or more classes of securities
('Structured Foreign Investments') backed by, or representing interests in, the
underlying instruments. The cash flow on the underlying instruments may be
apportioned among the newly issued Structured Foreign Investments to create
securities with different investment characteristics such as varying maturities,
payment priorities and interest rate provisions, and the extent of the payments
made with respect to Structured Foreign Investments is dependent on the extent
of the cash flow on the underlying instruments.
The Structured Foreign Investments of the type in which the Fund typically
will invest will involve no credit enhancement. Accordingly, their credit risk
generally will be equivalent to that of the underlying instruments. The Fund is
permitted, however, to invest in classes of Structured Foreign Investments that
are subordinated to the right of payment of another class. Subordinated
Structured Foreign Investments typically have higher yields and present greater
risks than unsubordinated Structured Foreign Investments. Structured Foreign
Investments are typically sold in private placement transactions, and there
currently is no active trading market for Structured Foreign Investments.
YIELD FACTORS AND RATINGS
S&P, Moody's and other NRSROs are private services that provide ratings of
the credit quality of fixed income securities. A description of the range of
ratings assigned to fixed income securities by S&P and Moody's is included in
Appendix A to the Prospectus. The Fund may use these ratings in determining
whether to purchase, sell or hold a security. Mitchell Hutchins will assess
securities on the basis of the highest rating assigned by any NRSRO. It should
be emphasized, however, that ratings are general and are not absolute standards
of quality. Consequently, fixed income securities with the same maturity,
interest rate and rating may have different market prices. Also, rating agencies
may fail to make timely changes in credit ratings in response to subsequent
events. Consequently, the rating assigned to any particular security is not
necessarily a reflection of the issuer's current financial condition, which may
be better or worse than the rating would indicate. The rating assigned to a
security by Moody's or S&P does not reflect an assessment of the volatility of
the security's market value or of the liquidity of an investment in the
security.
Changes by NRSROs in their ratings of any fixed income security and in the
ability of an issuer to make payments of interest and principal may also affect
the value of these investments. Changes in the value of portfolio securities
generally will not affect cash income derived from such securities, but will
affect the Fund's net asset value. The Fund will not necessarily dispose of a
security when its rating is reduced below the rating at the time of purchase,
although Mitchell Hutchins will monitor all investments to determine whether
continued investment is consistent with the Fund's investment objectives.
In addition to ratings assigned to individual security issues, Mitchell
Hutchins will analyze interest rate trends and developments that may affect
individual issuers, including factors such as liquidity, profitability and
credit quality. With respect to its investments in Foreign and Emerging Market
Securities, the Fund also will analyze factors such as currency exchange rate
movements, credit risks of the foreign countries and issuers, and political and
social climate. The yields on fixed income securities are dependent on a variety
of factors, including general money market
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conditions, general conditions in the bond market, the financial condition of
the issuer, the size of the offering, the maturity of the obligation and its
rating. There is a wide variation in the quality of fixed income securities,
both within a particular classification and between classifications. The
obligations of an issuer of fixed income securities are subject to the
provisions of bankruptcy, insolvency and other laws affecting the rights and
remedies of bond holders or other creditors of an issuer; litigation or other
conditions may also adversely affect the power or ability of issuers to meet
their obligations for the payment of interest and repayment of principal.
ILLIQUID SECURITIES
As indicated in the Prospectus, the Fund may invest up to 15% of its net
assets in illiquid securities. The term 'illiquid securities' for this purpose
means securities that cannot be disposed of within seven days in the ordinary
course of business at approximately the amount at which the Fund has valued the
securities and includes, among other things, purchased OTC options, repurchase
agreements maturing in more than seven days and restricted securities other than
those Mitchell Hutchins has determined are liquid pursuant to guidelines
established by the Trust's board of trustees. The assets used as cover for OTC
options written by the Fund will be considered illiquid unless the OTC options
are sold to qualified dealers who agree that the Fund may repurchase any OTC
option it writes at a maximum price to be calculated by a formula set forth in
the option agreement. The cover for an OTC option written subject to this
procedure would be considered illiquid only to the extent that the maximum
repurchase price under the formula exceeds the intrinsic value of the option.
Illiquid restricted securities may be sold only in privately negotiated
transactions or in public offerings with respect to which a registration
statement is in effect under the Securities Act of 1933 ('1933 Act'). Such
securities include those that are subject to restrictions contained in the
securities laws of other countries. However, securities that are freely
marketable in the country where they are principally traded, but would not be
freely marketable in the United States, will not be considered illiquid. Where
registration is required, the Fund may be obligated to pay all or part of the
registration expenses, and a considerable period may elapse between the time of
the decision to sell and the time the Fund may be permitted to sell a security
under an effective registration statement. If, during such a period, adverse
market conditions were to develop, the Fund might obtain a less favorable price
than prevailed when it decided to sell.
Not all restricted securities are illiquid. In recent years, a large
institutional market has developed for certain securities that are not
registered under the 1933 Act, including private placements, repurchase
agreements, commercial paper, foreign securities and corporate bonds and notes.
These instruments are often restricted securities because the securities are
sold in transactions not requiring registration. Institutional investors
generally will not seek to sell these instruments to the general public, but
instead will often depend either on an efficient institutional market in which
such unregistered securities can be readily resold or on an issuer's ability to
honor a demand for repayment. Therefore, the fact that there are contractual or
legal restrictions on resale to the general public or certain institutions is
not dispositive of the liquidity of such investments.
Rule 144A under the 1933 Act establishes a 'safe harbor' from the
registration requirements of the 1933 Act for resales of certain securities to
qualified institutional buyers. Institutional markets for restricted securities
have developed as a result of Rule 144A, providing both readily ascertainable
values for restricted securities and the ability to liquidate an investment to
satisfy share redemption orders or for other purposes. Such markets include
automated systems for the trading, clearance and settlement of unregistered
securities of domestic and foreign issuers, such as the PORTAL System sponsored
by the National Association of Securities Dealers, Inc. An insufficient number
of qualified buyers interested in purchasing Rule 144A-eligible restricted
securities held by the Fund, however, could affect adversely the marketability
of such portfolio securities, and the Fund might be unable to dispose of such
securities promptly or at favorable prices.
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The board of trustees has delegated the function of making day-to-day
determinations of liquidity to Mitchell Hutchins pursuant to guidelines approved
by the board. Mitchell Hutchins will take into account a number of factors in
reaching liquidity decisions, including (1) the frequency of trades for the
security, (2) the number of dealers that make quotes for the security, (3) the
number of dealers that have undertaken to make a market in the security, (4) the
number of other potential purchasers for the security and (5) the nature of the
security and how trading is effected (e.g., the time needed to sell the
security, how bids are solicited and the mechanics of transfer). Mitchell
Hutchins monitors the liquidity of restricted securities in the Fund's portfolio
and reports periodically on such decisions to the board of trustees.
CONVERTIBLE SECURITIES
The value of a convertible security is a function of its 'investment value'
(determined by its yield in comparison with the yields of other securities of
comparable maturity and quality that do not have a conversion privilege) and its
'conversion value' (the security's worth, at market value, if converted into the
underlying common stock). The investment value of a convertible security is
influenced by changes in interest rates, with investment value declining as
interest rates increase and increasing as interest rates decline. The credit
standing of the issuer and other factors also may have an effect on the
convertible security's investment value. The conversion value of a convertible
security is determined by the market price of the underlying common stock. If
the conversion value is low relative to the investment value, the price of the
convertible security is governed principally by its investment value. Generally,
the conversion value decreases as the convertible security approaches maturity.
To the extent the market price of the underlying common stock approaches or
exceeds the conversion price, the price of the convertible security will be
increasingly influenced by its conversion value. A convertible security
generally will sell at a premium over its conversion value by the extent to
which investors place value on the right to acquire the underlying common stock
while holding a fixed income security.
A convertible security might be subject to redemption at the option of the
issuer at a price established in the convertible security's governing
instrument. If a convertible security held by the Fund is called for redemption,
the Fund will be required to permit the issuer to redeem the security, convert
it into the underlying common stock or sell it to a third party. Any of these
actions could have an adverse effect on the Fund's ability to achieve its
investment objectives.
WARRANTS
The Fund may acquire warrants for equity securities, debt securities and
commodities that are acquired as units with fixed income securities. Warrants
are securities permitting, but not obligating, their holder to subscribe for
other securities or commodities. Warrants do not carry with them the right to
dividends or voting rights with respect to the securities that they entitle
their holder to purchase, and they do not represent any rights in the assets of
the issuer. As a result, warrants may be considered more speculative than
certain other types of investments. In addition, the value of a warrant does not
necessarily change with the value of the underlying securities, and a warrant
ceases to have value if it is not exercised prior to its expiration date. The
Fund does not intend to retain in its portfolio any common stock or commodity
received upon the exercise of a warrant and will sell the common stock or
commodity as promptly as practicable and in a manner that it believes will
reduce its risk of a loss in connection with the sale.
REPURCHASE AGREEMENTS
Repurchase agreements are transactions in which the Fund purchases
securities from a bank or recognized securities dealer and simultaneously
commits to resell those securities to the bank or dealer at an agreed-upon date
and price reflecting a market rate of interest unrelated to the coupon rate or
maturity of the purchased securities. The Fund will maintain custody of the
underlying securities prior to their repurchase; thus, the obligation of the
bank or securities dealer to pay the repurchase price on the date agreed to
will, in effect, be secured by such securities. If the
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value of such securities is less than the repurchase price, plus any agreed-upon
additional amount, the other party to the agreement will be required to provide
additional collateral so that at all times the collateral is at least equal to
the repurchase price, plus any agreed-upon additional amount. The difference
between the total amount to be received upon repurchase of the securities and
the price which was paid by the Fund upon acquisition will be accrued as
interest and included in the Fund's net investment income.
Repurchase agreements carry certain risks not associated with direct
investments in securities, including possible declines in the market value of
the underlying securities and delays and costs to the Fund if the other party to
the repurchase agreement becomes bankrupt. The Fund intends to enter into
repurchase agreements only with banks and dealers in transactions believed by
Mitchell Hutchins to present minimal credit risks in accordance with guidelines
established by the Trust's board of trustees. Mitchell Hutchins will review and
monitor the creditworthiness of such institutions under the board's general
supervision.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. As stated in the Prospectus,
the Fund may purchase securities on a 'when-issued' or delayed delivery basis. A
security purchased on a when-issued or delayed delivery basis is recorded as an
asset on the commitment date and is subject to changes in market value generally
based upon changes in the level of interest rates. Thus, fluctuation in the
value of the security from the time of the commitment date will affect the
Fund's net asset value. When the Fund agrees to purchase securities on a
when-issued basis, its custodian segregates assets to cover the amount of the
commitment. See 'Investment Policies and Restrictions--Segregated Accounts.'
The Fund purchases when-issued securities only with the intention of taking
delivery, but may sell the right to acquire the security prior to delivery if
Mitchell Hutchins deems it advantageous to do so, which may result in capital
gain or loss to the Fund.
SEGREGATED ACCOUNTS. When the Fund enters into certain transactions that
involve obligations to make future payments to third parties, including dollar
rolls, reverse repurchase agreements or the purchase of securities on a
when-issued or delayed delivery basis, the Fund will maintain with an approved
custodian in a segregated account cash, U.S. government securities or other
liquid high-grade debt securities, marked to market daily, in an amount at least
equal to the Fund's obligation or commitment under such transactions. As
described below under 'Hedging and Related Income Strategies,' segregated
accounts may also be required in connection with certain transactions involving
options or futures contracts, interest rate protection transactions or forward
currency contracts.
SHORT SALES 'AGAINST THE BOX.' As indicated in the prospectus, the Fund
may engage in short sales of securities it owns or has the right to acquire at
no added cost through conversion or exchange of other securities it owns (short
sales 'against the box') to defer realization of gains or losses for tax or
other purposes. To make delivery to the purchaser in a short sale, the executing
broker borrows the securities being sold short on behalf of the Fund, and the
Fund is obligated to replace the securities borrowed at a date in the future.
When the Fund sells short, it will establish a margin account with the broker
effecting the short sale, and will deposit collateral with the broker. In
addition, the Fund will maintain with its custodian, in a segregated account,
the securities that could be used to cover the short sale. The Fund will incur
transaction costs, including interest expense, in connection with opening,
maintaining and closing short sales against the box. The Fund currently does not
intend to have obligations under short-sales that at any time during the coming
year exceed 5% of the Fund's net assets.
The Fund might make a short sale 'against the box' in order to hedge
against market risks when Mitchell Hutchins believes that the price of a
security may decline, thereby causing a decline in the value of a security owned
by the Fund or a security convertible into or exchangeable for a security owned
by the Fund, or when Mitchell Hutchins wants to sell a security that the Fund
owns at a current price, but also wishes to defer recognition of gain or loss
for federal income tax purposes. In such case, any loss in the Fund's long
position after the short sale should be reduced by a gain in the short position.
Conversely, any gain in the long position should be reduced by a loss in the
short position. The extent to which gains or losses in the long position are
reduced will depend upon the amount of
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the securities sold short relative to the amount of the securities the Fund
owns, either directly or indirectly, and in the case where the Fund owns
convertible securities, changes in the investment values or conversion premiums
of such securities.
INVESTMENT LIMITATIONS OF THE FUND. The Fund will not:
(1) purchase any security if, as a result of that purchase, 25% or more of
the Fund's total assets would be invested in securities of issuers having their
principal business activities in the same industry, except that this limitation
does not apply to securities issued or guaranteed by the U.S. government, its
agencies or instrumentalities or to municipal securities.
(2) issue senior securities or borrow money, except as permitted under the
1940 Act and then not in excess of 33 1/3% of the Fund's total assets (including
the amount of the senior securities issued but reduced by any liabilities not
constituting senior securities) at the time of the issuance or borrowing, except
that the Fund may borrow up to an additional 5% of its total assets (not
including the amount borrowed) for temporary or emergency purposes.
(3) make loans, except through loans of portfolio securities or through
repurchase agreements, provided that for purposes of this restriction, the
acquisition of bonds, debentures, other debt securities or instruments, or
participations or other interests therein and investments in government
obligations, commercial paper, certificates of deposit, bankers' acceptances or
similar instruments will not be considered the making of a loan.
(4) engage in the business of underwriting securities of other issuers,
except to the extent that the Fund might be considered an underwriter under the
federal securities laws in connection with its disposition of portfolio
securities.
(5) purchase or sell real estate, except that investments in securities of
issuers that invest in real estate and investments in mortgage-backed
securities, mortgage participations or other instruments supported by interests
in real estate are not subject to this limitation, and except that the Fund may
exercise rights under agreements relating to such securities, including the
right to enforce security interests and to hold real estate acquired by reason
of such enforcement until that real estate can be liquidated in an orderly
manner.
(6) purchase or sell physical commodities unless acquired as a result of
owning securities or other instruments, but the Fund may purchase, sell or enter
into financial options and futures, forward and spot currency contracts, swap
transactions and other financial contracts or derivative instruments.
The foregoing fundamental investment limitations cannot be changed without the
affirmative vote of the lesser of (a) more than 50% of the outstanding shares of
the Fund or (b) 67% or more of such shares present at a stockholders' meeting if
more than 50% of the outstanding shares are represented at the meeting in person
or by proxy. If a percentage restriction is adhered to at the time of an
investment or transaction, later changes in percentage resulting from a change
in values of portfolio securities or the amount of total assets will not be
considered a violation of any of the Fund's investment limitations, restrictions
or investment policies.
The following investment restrictions are not fundamental and may be
changed by the Trust's board of trustees without shareholder approval.
The Fund will not:
(1) purchase or retain the securities of any issuer if the officers and
trustees of the Trust and the officers and directors of Mitchell Hutchins (each
owning beneficially more than 0.5% of the outstanding securities of the issuer)
own in the aggregate more than 5% of the securities of the issuer.
(2) purchase any security if as a result more than 5% of the Fund's total
assets would be invested in securities of companies that, together with any
predecessors, have been in continuous operation for less than three years,
provided, however, that this shall not apply to mortgage- and asset-backed
securities and Structured Foreign Investments.
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(3) invest more than 15% of its net assets in illiquid securities, a term
that means securities that cannot be disposed of within seven days in the
ordinary course of business at approximately the amount at which the Fund has
valued the securities and includes, among other things, repurchase agreements
maturing in more than seven days.
(4) purchase securities of any one issuer if as a result the Fund would own
or hold 10% of the outstanding voting securities of that issuer, except that up
to 25% of the Fund's total assets may be invested without regard to this
limitation.
(5) make investments in warrants, valued at the lower of cost or market, in
excess of 5% of the value of its net assets, which amount may include warrants
that are not listed on the New York Stock Exchange, Inc. ('NYSE') or the
American Stock Exchange, Inc. provided that such unlisted warrants, valued at
the lower of cost or market, do not exceed 2% of the Fund's net assets, and
further provided that this restriction does not apply to warrants attached to,
or sold as a unit with, other securities. For purposes of this restriction, the
term 'warrants' does not include options on securities, currencies, stock or
bond indices, or futures contracts.
(6) purchase securities on margin, except for short-term credit necessary
for clearance of portfolio transactions and except that the Fund may make margin
deposits in connection with its use of financial options and futures, forward
and spot currency contracts, swap transactions and other financial contracts or
derivative instruments.
(7) engage in short sales of securities or maintain a short position,
except that the Fund may (a) sell short 'against the box' and (b) maintain short
positions in connection with its use of financial options and futures, forward
and spot currency contracts, swap transactions and other financial contracts or
derivative instruments.
(8) invest in oil, gas or mineral exploration or development programs or
leases, except that investments in securities of issuers that invest in such
programs or leases and investments in asset-backed securities supported by
receivables generated from such programs or leases are not subject to this
prohibition.
(9) invest in real estate limited partnerships.
HEDGING AND RELATED INCOME STRATEGIES
As discussed in the Prospectus, Mitchell Hutchins may use a variety of
financial instruments ('Hedging Instruments'), including options, futures
contracts (sometimes referred to as 'futures') and options on futures contracts
to attempt to hedge the Fund's portfolio and to enhance income. Mitchell
Hutchins also may attempt to hedge the Fund's portfolio through the use of
foreign currency forward contracts and interest rate protection transactions.
Further information regarding certain of the Hedging Instruments that may be
used by the Fund is contained in Appendix C to the Fund's Prospectus.
Hedging strategies can be broadly categorized as 'short hedges' and 'long
hedges.' A short hedge is a purchase or sale of a Hedging Instrument intended
partially or fully to offset potential declines in the value of one or more
investments held in the Fund's portfolio. Thus, in a short hedge the Fund takes
a position in a Hedging Instrument whose price is expected to move in the
opposite direction of the price of the investment being hedged. For example, the
Fund might purchase a put option on a security to hedge against a potential
decline in the value of that security. If the price of the security declined
below the exercise price of the put, the Fund could exercise the put and thus
limit its loss below the exercise price to the premium paid plus transaction
costs. In the alternative, because the value of the put option can be expected
to increase as the value of the underlying security declines, the Fund might be
able to close out the put option and realize a gain to offset the decline in the
value of the security.
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Conversely, a long hedge is a purchase or sale of a Hedging Instrument
intended partially or fully to offset potential increases in the acquisition
cost of one or more investments that the Fund intends to acquire. Thus, in a
long hedge, the Fund takes a position in a Hedging Instrument whose price is
expected to move in the same direction as the price of the prospective
investment being hedged. For example, the Fund might purchase a call option on a
security it intends to purchase in order to hedge against an increase in the
cost of the security. If the price of the security increased above the exercise
price of the call, the Fund could exercise the call and thus limit its
acquisition to the exercise price plus the premium paid and transaction costs.
Alternatively, the Fund might be able to offset the price increase by closing
out an appreciated call option and realizing a gain.
The Fund may purchase and write (sell) covered straddles on securities or
indices of debt securities. A long straddle is a combination of a call and a put
option purchased on the same security or on the same futures contract, where the
exercise price of the put is less than or equal to the exercise price of the
call. The Fund might enter into a long straddle when Mitchell Hutchins believes
that it is likely that interest rates will be more volatile during the term of
the option than the option pricing implies. A short straddle is a combination of
a call and a put written on the same security where the exercise price of the
put is less than or equal to the exercise price of the call. The Fund might
enter into a short straddle when Mitchell Hutchins believes that it is unlikely
that interest rates will be as volatile during the term of the option as the
option pricing implies.
Hedging Instruments on securities generally are used to hedge against price
movements in one or more particular securities positions that the Fund owns or
intends to acquire. Hedging Instruments on debt securities may be used to hedge
either individual securities or broad fixed income market sectors.
The use of Hedging Instruments is subject to applicable regulations of the
SEC, the several options and futures exchanges upon which they are traded and
the Commodity Futures Trading Commission ('CFTC'). In addition, the Fund's
ability to use Hedging Instruments will be limited by tax considerations. See
'Taxes.'
In addition to the products, strategies and risks described below and in
the Prospectus, Mitchell Hutchins expects to discover additional opportunities
to develop in connection with options, futures contracts, forward currency
contracts and other hedging techniques. These new opportunities may become
available as Mitchell Hutchins develops new techniques, as regulatory
authorities broaden the range of permitted transactions and as new options,
futures contracts, forward currency contracts or other techniques are developed.
Mitchell Hutchins may utilize these opportunities to the extent that they are
consistent with the Fund's investment objectives and permitted by the Fund's
investment limitations and applicable regulatory authorities. The Fund's
Prospectus or Statement of Additional Information will be supplemented to the
extent that new products or techniques involve materially different risks than
those described below or in the Prospectus.
SPECIAL RISKS OF HEDGING STRATEGIES
The use of Hedging Instruments involves special considerations and risks,
as described below. Risks pertaining to particular Hedging Instruments are
described in the sections that follow.
(1) Successful use of most Hedging Instruments depends upon Mitchell
Hutchins' ability to predict movements of the overall securities, currencies and
interest rate markets, which requires different skills than predicting changes
in the prices of individual securities. While Mitchell Hutchins is experienced
in the use of Hedging Instruments, there can be no assurance that any particular
hedging strategy adopted will succeed.
(2) There might be imperfect correlation, or even no correlation, between
price movements of a Hedging Instrument and price movements of the investments
being hedged. For example, if the value of a Hedging Instrument used in a short
hedge increased by less than the decline in value of the hedged investment, the
hedge would not be
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fully successful. Such a lack of correlation might occur due to factors
unrelated to the value of the investments being hedged, such as speculative or
other pressures on the markets in which Hedging Instruments are traded. The
effectiveness of hedges using Hedging Instruments on indices will depend on the
degree of correlation between price movements in the index and price movements
in the investments being hedged.
(3) Hedging strategies, if successful, can reduce risk of loss by wholly or
partially offsetting the negative effect of unfavorable price movements in the
investments being hedged. However, hedging strategies can also reduce
opportunity for gain by offsetting the positive effect of favorable price
movements in the hedged investments. For example, if the Fund entered into a
short hedge because Mitchell Hutchins projected a decline in the price of a
security in the Fund's portfolio, and the price of that security increased
instead, the gain from that increase might be wholly or partially offset by a
decline in the price of the Hedging Instrument. Moreover, if the price of the
Hedging Instrument declined by more than the increase in the price of the
security, the Fund could suffer a loss. In either such case, the Fund would have
been in a better position had it not hedged at all.
(4) As described below, the Fund might be required to maintain assets as
'cover,' maintain segregated accounts or make margin payments when it takes
positions in Hedging Instruments involving obligations to third parties (i.e.,
Hedging Instruments other than purchased options). If the Fund were unable to
close out its positions in such Hedging Instruments, it might be required to
continue to maintain such assets or accounts to make such payments until the
position expired or matured. These requirements might impair the Fund's ability
to sell a portfolio security or make an investment at a time when it would
otherwise be favorable to do so, or require that the Fund sell a portfolio
security at a disadvantageous time. The Fund's ability to close out a position
in a Hedging Instrument prior to expiration or maturity depends on the existence
of a liquid secondary market or, in the absence of such a market, the ability
and willingness of the other party to the transaction ('contra party') to enter
into a transaction closing out the position. Therefore, there is no assurance
that any hedging position can be closed out at a time and price that is
favorable to the Fund.
COVER FOR HEDGING STRATEGIES
Transactions using Hedging Instruments, other than purchased options,
expose the Fund to an obligation to another party. The Fund will not enter into
any such transactions unless it owns either (1) an offsetting ('covered')
position in securities, currencies or other options, futures contracts or
forward currency contracts or (2) cash and short-term debt securities, with a
value sufficient at all times to cover its potential obligations to the extent
not covered as provided in (1) above. The Fund will comply with SEC guidelines
regarding cover for hedging transactions and will, if the guidelines so require,
set aside cash, U.S. government securities or other liquid, high-grade debt
securities in a segregated account with its custodian in the prescribed amount.
Assets used as cover or held in a segregated account cannot be sold while
the position in the corresponding Hedging Instrument is open, unless they are
replaced with similar assets. As a result, the commitment of a large portion of
the Fund's assets to cover or segregated accounts could impede portfolio
management or the Fund's ability to meet redemption requests or other current
obligations.
OPTIONS
The Fund may purchase put and call options, and write covered put and call
options, on debt securities, on indices of debt securities and foreign
currencies. The purchase of call options serves as a long hedge, and the
purchase of put options serves as a short hedge. Writing covered put or call
options can enable the Fund to enhance income by reason of the premiums paid by
the purchasers of such options. Writing covered put options serves as a limited
long hedge because increases in the value of the hedged investment would be
offset to the extent of the premium received
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for writing the option. However, if the market price of the security underlying
a put option the Fund has written declines to less than the exercise price of
the option, minus the premium received, the Fund would expect to suffer a loss.
Writing covered call options serves as a limited short hedge because declines in
the value of the hedged investment would be offset to the extent of the premium
received for writing the option. However, if the security appreciates to a price
higher than the exercise price of the call option, it can be expected that the
option will be exercised and the Fund will be obligated to sell the security at
less than its market value. All or a portion of the assets used as cover for OTC
options written by the Fund would be considered illiquid to the extent described
under 'Investment Policies and Restrictions--Illiquid Securities.'
The value of an option position will reflect, among other things, the
current market value of the underlying investment, the time remaining until
expiration, the relationship of the exercise price to the market price of the
underlying investment, the historical price volatility of the underlying
investment and general market conditions. Generally, the OTC debt and foreign
currency options used by the Fund are European-style options. This means that
the option is only exercisable immediately prior to its expiration. This is in
contrast to American-style options, which are exercisable at any time prior to
the expiration date of the option. Options that expire unexercised have no
value.
The Fund may effectively terminate its right or obligation under an option
by entering into a closing transaction. For example, the Fund may terminate its
obligation under a call or put option that it had written by purchasing an
identical call or put option; this is known as a closing purchase transaction.
Conversely, the Fund may terminate a position in a put or call option it had
purchased by writing an identical put or call option; this is known as a closing
sale transaction. Closing transactions permit the Fund to realize the profit or
limit the loss on an option position prior to its exercise or expiration.
The Fund may purchase or write both exchange-traded and OTC options.
Exchange markets for options on debt securities and foreign currencies exist but
are relatively new, and these instruments are primarily traded on the OTC
market. Exchange-traded options in the United States are issued by a clearing
organization affiliated with the exchange on which the option is listed which,
in effect, guarantees completion of every exchange-traded option transaction. In
contrast, OTC options are contracts between the Fund and its contra party
(usually a securities dealer or a bank) with no clearing organization guarantee.
Thus, when the Fund purchases or writes an OTC option, it relies on the contra
party to make or take delivery of the underlying investment upon exercise of the
option. Failure by the contra party to do so would result in the loss of any
premium paid by the Fund as well as the loss of any expected benefit of the
transaction. The Fund will enter into OTC option transactions only with contra
parties that have a net worth of at least $20 million.
The Fund's ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. The Fund intends to
purchase or write only those exchange-traded options for which there appears to
be a liquid secondary market. However, there can be no assurance that such a
market will exist at any particular time. Closing transactions can be made for
OTC options only by negotiating directly with the contra party, or by a
transaction in the secondary market if any such market exists. Although the Fund
will enter into OTC options only with contra parties that are expected to be
capable of entering into closing transactions with the Fund, there is no
assurance that the Fund will in fact be able to close out an OTC option at a
favorable price prior to expiration. In the event of insolvency of the contra
party, the Fund might be unable to close out an OTC option position at any time
prior to its expiration.
If the Fund were unable to effect a closing transaction for an option it
had purchased, it would have to exercise the option to realize any profit. The
inability to enter into a closing purchase transaction for a covered call option
written by the Fund could cause material losses because the Fund would be unable
to sell the investment used as cover for the written option until the option
expires or is exercised.
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The Fund may purchase and write put and call options on indices of debt
securities in much the same manner as the more traditional options discussed
above, except the index options may serve as a hedge against overall
fluctuations in the debt securities market (or market sectors) rather than
anticipated increases or decreases in the value of a particular security.
GUIDELINES FOR OPTIONS
The Fund's use of options is governed by the following guidelines, which
can be changed by the Trust's board of trustees without shareholder vote:
1. The Fund may purchase a put or call option, including any straddles or
spreads, only if the value of its premium, when aggregated with the premiums on
all other options purchased by the Fund, does not exceed 5% of the Fund's total
assets.
2. The aggregate value of securities underlying put options written by the
Fund determined as of the date the put options are written, will not exceed 50%
of the Fund's net assets.
3. The aggregate premiums paid on all options (including options on
securities, foreign currencies and indices of securities and options on futures
contracts) purchased by the Fund that are held at any time will not exceed 20%
of the Fund's net assets.
FUTURES
The Fund may purchase and sell interest rate futures contracts, debt and
equity index futures contracts and foreign currency futures contracts. The Fund
may also purchase put and call options, and write covered put and call options,
on futures in which it is allowed to invest. The purchase of futures or call
options thereon can serve as a long hedge, and the sale of futures or the
purchase of put options thereon can serve as a short hedge. Writing covered call
options on futures contracts can serve as a limited short hedge, and writing
covered put options on futures contracts can serve as a limited long hedge,
using a strategy similar to that used for writing covered options in securities
on indices.
Futures strategies also can be used to manage the average duration of the
Fund's portfolio. If Mitchell Hutchins wishes to shorten the average duration of
the Fund, the Fund may sell an interest rate or debt security index futures
contract or a call option thereon or purchase a put option on that futures
contract. If Mitchell Hutchins wishes to lengthen the average duration of the
Fund, the Fund may buy an interest rate or debt security index futures contract
or a call option thereon or sell a put option thereon.
The Fund may also write put options on interest rate futures contracts
while at the same time purchasing call options on the same futures contracts in
order synthetically to create a long futures contract position. Such options
would have the same strike prices and expiration dates. The Fund will engage in
this strategy only when it is more advantageous to the Fund than is purchasing
the futures contract.
No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract, the Fund is required to deposit in a segregated
account with its custodian, in the name of the futures broker through whom the
transaction was effected, 'initial margin' consisting of cash, U.S. government
securities or other liquid, high-grade debt securities, in an amount generally
equal to 10% or less of the contract value. Margin must also be deposited when
writing an option on a futures contract, in accordance with applicable exchange
rules. Unlike margin in securities transactions, initial margin on futures
contracts does not represent a borrowing, but rather is in the nature of a
performance bond or good-faith deposit that is returned to the Fund at the
termination of the transaction if all contractual obligations have been
satisfied. Under certain circumstances, such as periods of high volatility, the
Fund
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may be required by an exchange to increase the level of its initial margin
payment. Initial margin requirements might be increased generally by future
regulatory action.
Subsequent 'variation margin' payments are made to and from the futures
broker daily as the value of the futures or written option position varies, a
process known as 'marking to market.' Variation margin does not involve
borrowing, but rather represents a daily settlement of the Fund's obligations
with respect to an open futures or options position. When the Fund purchases an
option on a future, the premium paid plus transaction costs is all that is at
risk. In contrast, when the Fund purchases or sells a futures contract or writes
an option thereon, it is subject to daily variation margin calls that could be
substantial in the event of adverse price movements. If the Fund has
insufficient cash to meet daily variation margin requirements, it might need to
sell securities at a time when such sales are disadvantageous.
Holders and writers of futures positions and options on futures can enter
into offsetting closing transactions, similar to closing transactions on
options, by selling or purchasing, respectively, an instrument identical to the
instrument held or written. Positions in futures and options on futures may be
closed only on an exchange or board of trade that provides a secondary market.
The Fund intends to enter into futures transactions only on exchanges or boards
of trade where there appears to be a liquid, secondary market. However, there
can be no assurance that such a market will exist for a particular contract at a
particular time.
Under certain circumstances, futures exchanges may establish daily limits
on the amount that the price of a future or related option can vary from the
previous day's settlement price; once that limit is reached, no trades may be
made that day at a price beyond the limit. Daily price limits do not limit
potential losses because prices could move to the daily limit for several
consecutive days with little or no trading, thereby preventing liquidation of
unfavorable positions.
If the Fund were unable to liquidate a futures or options position due to
the absence of a liquid secondary market or the imposition of price limits, it
could incur substantial losses. The Fund would continue to be subject to market
risk with respect to the position. In addition, except in the case of purchased
options, the Fund would continue to be required to make daily variation margin
payments and might be required to maintain the position being hedged by the
future or option or to maintain cash or securities in a segregated account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or related options might not
correlate perfectly with movements in the prices of the investments being
hedged. For example, all participants in the futures and options markets are
subject to daily variation margin calls and might be compelled to liquidate
futures or related options positions whose prices are moving unfavorably to
avoid being subject to further calls. These liquidations could increase price
volatility of the instruments and distort the normal price relationship between
the futures or related options and the investments being hedged. Also, because
initial margin deposit requirements in the futures market are less onerous than
margin requirements in the securities markets, there might be increased
participation by speculators in the futures markets. This participation also
might cause temporary price distortions. In addition, activities of large
traders in both the futures and securities markets involving arbitrage, 'program
trading' and other investment strategies might result in temporary price
distortions.
GUIDELINES FOR FUTURES AND RELATED OPTIONS
The Fund's use of futures and related options is governed by the following
guidelines which can be changed by the Trust's board of trustees without
shareholder vote:
1. To the extent the Fund enters into futures contracts and options on
futures positions including options on foreign currencies traded on a
commodities exchange, that are not for bona fide hedging purposes (as defined by
the
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CFTC), the aggregate initial margin and premiums on those positions (excluding
the amount by which options are 'in-the-money') may not exceed 5% of the Fund's
net assets.
2. The aggregate premiums paid on all options (including options on
securities, foreign currencies and indices of debt securities and options on
futures contracts) purchased by the Fund that are held at any time will not
exceed 20% of the Fund's net assets.
3. The aggregate margin deposits on all futures contracts and options
thereon held at any time by the Fund will not exceed 5% of the Fund's total
assets.
FOREIGN CURRENCY HEDGING STRATEGIES--SPECIAL CONSIDERATIONS
The Fund may use options and futures on foreign currencies, as described
above, and foreign currency forward contracts, as described below, to hedge
against movements in the values of the foreign currencies in which the Fund's
securities are denominated. Such currency hedges can protect against price
movements in a security that the Fund owns or intends to acquire that are
attributable to changes in the value of the currency in which it is denominated.
Such hedges do not, however, protect against price movements in the securities
that are attributable to other causes.
The Fund might seek to hedge against changes in the value of a particular
currency when no Hedging Instruments on that currency are available or such
Hedging Instruments are more expensive than certain other Hedging Instruments.
In such cases, the Fund may hedge against price movements in that currency by
entering into transactions using Hedging Instruments on another foreign currency
or basket of currencies, the values of which Mitchell Hutchins believes will
have a positive correlation to the value of the currency being hedged. The risk
that movements in the price of the Hedging Instrument will not correlate
perfectly with movements in the price of the currency being hedged is magnified
when this strategy is used.
The value of Hedging Instruments on foreign currencies depends on the value
of the underlying currency relative to the U.S. dollar. Because foreign currency
transactions occurring in the interbank market might involve substantially
larger amounts than those involved in the use of such Hedging Instruments, the
Fund could be disadvantaged by having to deal in the odd lot market (generally
consisting of transactions of less than $1 million) for the underlying foreign
currencies at prices that are less favorable than for round lots.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations available through
dealers or other market sources be firm or revised on a timely basis. Quotation
information generally is representative of very large transactions in the
interbank market and thus might not reflect odd-lot transactions where rates
might be less favorable. The interbank market in foreign currencies is a global,
round-the-clock market. To the extent the U.S. options or futures markets are
closed while the markets for the underlying currencies remain open, significant
price and rate movements might take place in the underlying markets that cannot
be reflected in the markets for the Hedging Instruments until they reopen.
Settlement of hedging transactions involving foreign currencies might be
required to take place within the country issuing the underlying currency. Thus,
the Fund might be required to accept or make delivery of the underlying foreign
currency in accordance with any U.S. or foreign regulations regarding the
maintenance of foreign banking arrangements by U.S. residents and might be
required to pay any fees, taxes and charges associated with such delivery
assessed in the issuing country.
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FORWARD CURRENCY CONTRACTS
The Fund may enter into forward currency contracts to purchase or sell
foreign currencies for a fixed amount of U.S. dollars or another foreign
currency. Such transactions may serve as long hedges--for example, the Fund may
purchase a forward currency contract to lock in the U.S. dollar price of a
security denominated in a foreign currency that the Fund intends to acquire.
Forward currency contract transactions may also serve as short hedges--for
example, the Fund may sell a forward currency contract to lock in the U.S.
dollar equivalent of the proceeds from the anticipated sale of a security
denominated in a foreign currency.
As noted above, the Fund may seek to hedge against changes in the value of
a particular currency by using forward contracts on another foreign currency or
a basket of currencies, the value of which Mitchell Hutchins believes will have
a positive correlation to the values of the currency being hedged. In addition,
the Fund may use forward currency contracts to shift exposure to foreign
currency fluctuations from one country to another. For example, if the Fund
owned securities denominated in a foreign currency and Mitchell Hutchins
believed that currency would decline relative to another currency, it might
enter into a forward contract to sell an appropriate amount of the first foreign
currency, with payment to be made in the second foreign currency. Transactions
that use two foreign currencies are sometimes referred to as 'cross hedging.'
Use of a different foreign currency magnifies the risk that movements in the
price of the Hedging Instrument will not correlate or will correlate unfavorably
with the foreign currency being hedged.
The cost to the Fund of engaging in forward currency contracts varies with
factors such as the currency involved, the length of the contract period and the
market conditions then prevailing. Because forward currency contracts are
usually entered into on a principal basis, no fees or commissions are involved.
When the Fund enters into a forward currency contract, it relies on the contra
party to make or take delivery of the underlying currency at the maturity of the
contract. Failure by the contra party to do so would result in the loss of any
expected benefit of the transaction.
As is the case with futures contracts, purchasers and sellers of forward
currency contracts can enter into offsetting closing transactions, similar to
closing transactions on futures, by selling or purchasing, respectively, an
instrument identical to the instrument purchased or sold. Secondary markets
generally do not exist for forward currency contracts, with the result that
closing transactions generally can be made for forward currency contracts only
by negotiating directly with the contra party. Thus, there can be no assurance
that the Fund will in fact be able to close out a forward currency contract at a
favorable price prior to maturity. In addition, in the event of insolvency of
the contra party, the Fund might be unable to close out a forward currency
contract at any time prior to maturity. In either event, the Fund would continue
to be subject to market risk with respect to the position and would continue to
be required to maintain a position in securities denominated in the foreign
currency that is the subject of the hedge or to maintain cash or securities in a
segregated account.
The precise matching of forward currency contract amounts and the value of
the securities involved generally will not be possible because the value of such
securities, measured in the foreign currency, will change after the foreign
currency contract has been established. Thus, the Fund might need to purchase or
sell foreign currencies in the spot (cash) market to the extent such foreign
currencies are not covered by forward currency contracts. The projection of
short-term currency market movements is extremely difficult, and the successful
execution of a short-term hedging strategy is highly uncertain.
LIMITATIONS ON THE USE OF FORWARD CURRENCY CONTRACTS
The Fund may enter into forward currency contracts or maintain a net
exposure to such contracts only if: (1) the consummation of the contracts would
not obligate the Fund to deliver an amount of foreign currency in excess of the
value of the position being hedged by such contracts; or (2) the Fund maintains
cash, U.S. government securities or
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liquid, high-grade debt securities in a segregated account in an amount not less
than the value of its total assets committed to the consummation of the contract
and not covered as provided in (1) above, as marked to market daily.
INTEREST RATE PROTECTION TRANSACTIONS
The Fund may enter into interest rate protection transactions, including
interest rate swaps and interest rate caps, collars and floors. Interest rate
swap transactions involve an agreement between two parties to exchange payments
that are based, respectively, on variable and fixed rates of interest and that
are calculated on the basis of a specified amount of principal (the 'notional
principal amount') for a specified period of time. Interest rate cap and floor
transactions involve an agreement between two parties in which the first party
agrees to make payments to the counterparty when a designated market interest
rate goes above (in the case of a cap) or below (in the case of a floor) a
designated level on predetermined dates or during a specified time period.
Interest rate collar transactions involve an agreement between two parties in
which payments are made when a designated market interest rate either goes above
a designated ceiling level or goes below a designated floor on predetermined
dates or during a specified time period. The Fund intends to use these
transactions as a hedge and not as a speculative investment. Interest rate
protection transactions are subject to risks comparable to those described above
with respect to other hedging strategies.
The Fund may enter into interest rate swaps, caps, collars and floors on
either an asset-based or liability-based basis, depending on whether it is
hedging its assets or its liabilities, and will usually enter into interest rate
swaps on a net basis, i.e., the two payment streams are netted out, with the
Fund receiving or paying as the case may be, only the net amount of the two
payments. Inasmuch as these interest rate protection transactions are entered
into for good faith hedging purposes, and inasmuch as segregated accounts will
be established with respect to such transactions, Mitchell Hutchins and the Fund
believe such obligations do not constitute senior securities and, accordingly,
will not treat them as being subject to its borrowing restrictions. The net
amount of the excess, if any, of the Fund's obligations over its entitlements
with respect to each interest rate swap will be accrued on a daily basis and an
amount of cash, U.S. government securities or other liquid, high-grade debt
obligations having an aggregate net asset value at least equal to the accrued
excess will be maintained in a segregated account by a custodian that satisfies
the requirements of the 1940 Act. The Fund also will establish and maintain such
segregated accounts with respect to its total obligations under any interest
rate swaps that are not entered into on a net basis and with respect to any
interest rate caps, collars and floors that are written by the Fund.
The Fund will enter into interest rate protection transactions only with
banks and recognized securities dealers believed by Mitchell Hutchins to present
minimal credit risks in accordance with guidelines established by the Trust's
board of trustees. If there is a default by the other party to such a
transaction, the Fund will have to rely on its contractual remedies (which may
be limited by bankruptcy, insolvency or similar laws) pursuant to the agreements
related to the transaction.
19
<PAGE>
TRUSTEES AND OFFICERS
The trustees and executive officers of the Trust, their ages, business
addresses and principal occupations during the past five years are:
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE WITH THE TRUST OTHER DIRECTORSHIPS
- -------------------------------- ------------------------- ----------------------------------------------------------
<S> <C> <C>
Margo N. Alexander;**49 Trustee and President Mrs. Alexander is president, chief executive officer and a
director of Mitchell Hutchins (since January 1995) and
also an executive vice-president and a director of
PaineWebber. Mrs. Alexander is president and a director
or trustee of 30 investment companies for which Mitchell
Hutchins or PaineWebber serves as investment adviser.
Richard Q. Armstrong; 60 Trustee Mr. Armstrong is chairman and principal of RQA Enterprises
78 West Brother Drive (management consulting firm) (since April 1991 and
Greenwich, CT 06830 principal occupation since March 1995). Mr. Armstrong is
also a director of HiLo Automotive Inc. He was chairman
of the board, chief executive officer and co-owner of
Adirondack Beverages (producer and distributor of soft
drinks and sparkling/still waters) (October 1993-March
1995). Mr. Armstrong was a partner of The New England
Consulting Group (management consulting firm) (December
1992-September 1993). He was managing director of LVMH
U.S. Corporation (U.S. subsidiary of the French luxury
goods conglomerate, Luis Vuitton Moet Hennessey
Corporation) (1987-1991) and chairman of its wine and
spirits subsidiary, Schieffelin & Somerset Company
(1987-1991). Mr. Armstrong is a director or trustee of
29 investment companies for which Mitchell Hutchins or
PaineWebber serves as investment adviser.
E. Garrett Bewkes, Jr.;**69 Trustee and Chairman Mr. Bewkes is a director of Paine Webber Group Inc. ('PW
of the Board of Group') (holding company of PaineWebber and Mitchell
Trustees Hutchins). Prior to December 1995, he was a consultant
to PW Group. Prior to 1988, he was chairman of the
board, president and chief executive officer of American
Bakeries Company. Mr. Bewkes is a director of Interstate
Bakeries Corporation and NaPro BioTherapeutics, Inc. Mr.
Bewkes is a director or trustee of 30 investment
companies for which Mitchell Hutchins or PaineWebber
serves as investment adviser.
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE WITH THE TRUST OTHER DIRECTORSHIPS
- -------------------------------- ------------------------- ----------------------------------------------------------
<S> <C> <C>
Richard R. Burt; 49 Trustee Mr. Burt is chairman of International Equity Partners
1101 Connecticut Avenue, N.W. (international investments and consulting firm) (since
Washington, D.C. 20036 March 1994) and a partner of McKinsey & Company
(management consulting firm) (since 1991). He is also a
director of American Publishing Company. He was the
chief negotiator in the Strategic Arms Reduction Talks
with the former Soviet Union (1989-1991) and the U.S.
ambassador to the Federal Republic of Germany
(1985-1989). Mr. Burt is a director or trustee of 29
investment companies for which Mitchell Hutchins or
PaineWebber serves as investment adviser.
Mary C. Farrell;** 46 Trustee Ms. Farrell is a managing director, senior investment
strategist, and member of the Investment Policy
Committee of PaineWebber. Ms. Farrell joined PaineWebber
in 1982. She is a member of the Financial Women's
Association and Women's Economic Roundtable, and is
employed as a regular panelist on Wall Street Week with
Louis Rukeyser. She also serves on the Board of
Overseers of New York University's Stern School of
Business. Ms. Farrell is a director or trustee of 29
investment companies for which Mitchell Hutchins or
PaineWebber serves as investment adviser.
Meyer Feldberg; 54 President Mr. Feldberg is Dean and Professor of Management of the
Columbia University Graduate School of Business, Columbia University. Prior
101 Uris Hall to 1989, he was president of the Illinois Institute of
New York, NY 10027 Technology. Dean Feldberg is also a director of AMSCO
International Inc., Federated Department Stores, Inc.
and New World Communications Group Incorporated. Dean
Feldberg is a director or trustee of 29 investment
companies for which Mitchell Hutchins or PaineWebber
serves as investment adviser.
George W. Gowen; 66 Trustee Mr. Gowen is a partner in the law firm of Dunnington,
666 Third Avenue Bartholow & Miller. Prior to May 1994, he was a partner
New York, NY 10017 in the law firm of Fryer, Ross & Gowen. Mr. Gowen is a
director of Columbia Real Estate Investments, Inc. Mr.
Gowen is a director or trustee of 29 investment
companies for which Mitchell Hutchins or PaineWebber
serves as investment adviser.
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE WITH THE TRUST OTHER DIRECTORSHIPS
- -------------------------------- ------------------------- ----------------------------------------------------------
<S> <C> <C>
Frederic V. Malek; 59 Trustee Mr. Malek is chairman of Thayer Capital Partners
901 15th Street, N.W. (investment bank) and a co-chairman and director of CB
Suite 300 Commercial Group Inc. (real estate). From January 1992
Washington, D.C. 20005 to November 1992, he was campaign manager of Bush-Quayle
'92. From 1990 to 1992, he was vice chairman and, from
1989 to 1990, he was president of Northwest Airlines
Inc., NWA Inc. (holding company of Northwest Airlines
Inc.) and Wings Holding Inc. (holding company of NWA
Inc.). Prior to 1989, he was employed by the Marriott
Corporation (hotels, restaurants, airline catering and
contract feeding), where he most recently was an
executive vice president and president of Marriott
Hotels and Resorts. Mr. Malek is also a director of
American Management Systems, Inc., Automatic Data
Processing, Inc., Avis, Inc., FPL Group, Inc., ICF
International Manor Care, Inc., National Education
Corporation and Northwest Airlines Inc. Mr. Malek is a
director or trustee of 29 investment companies for which
Mitchell Hutchins or PaineWebber serves as investment
adviser.
Carl W. Schafer; 60 Trustee Mr. Schafer is president of the Atlantic Foundation
P.O. Box 1164 (charitable foundation supporting mainly oceanographic
Princeton, NJ 08542 exploration and research). He also is a director of
Roadway Express, Inc. (trucking), The Guardian Group of
Mutual Funds, Evans Systems, Inc. (a motor fuels,
convenience store and diversified company), Hidden Lake
Gold Mines Ltd. (gold mining), Electronic Clearing
House, Inc. (financial transactions processing), Wainoco
Oil Corporation and Nutraceutix Inc. (biotechnology).
Prior to January 1993, Mr. Schafer was chairman of the
Investment Advisory Committee of the Howard Hughes
Medical Institute. Mr. Schafer is a director or trustee
of 29 investment companies for which Mitchell Hutchins
or PaineWebber serves as investment adviser.
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE WITH THE TRUST OTHER DIRECTORSHIPS
- -------------------------------- ------------------------- ----------------------------------------------------------
<S> <C> <C>
John R. Torell III; 56 Trustee Mr. Torell is chairman of Torell Management, Inc.
767 Fifth Avenue (financial advisory firm), chairman of Telesphere
Suite 4605 Corporation (electronic provider of financial
New York, NY 10153 information), and a partner of Zilkha & Company
(merchant banking and private investment company). He is
the former chairman and chief executive officer of
Fortune Bancorp (1990-1991 and 1990-1994, respectively),
the former chairman, president and chief executive
officer of CalFed, Inc. (savings association) (1988 to
1989) and former president of Manufacturers Hanover
Corp. (bank) (prior to 1988). Mr. Torrell is also a
director of American Home Products Corp., Volt
Information Sciences Inc., and New Colt Inc. (armament
manufacturer). Mr. Torell is a director or trustee of 29
investment companies for which Mitchell Hutchins or
PaineWebber serves as investment adviser.
Teresa M. Boyle; 37 Vice President Ms. Boyle is a first vice president and manager--advisory
administration of Mitchell Hutchins. Prior to November
1993, she was compliance manager of Hyperion Capital
Management, Inc., an investment advisory firm. Prior to
April 1993, Ms. Boyle was a vice president and
manager--legal administration of Mitchell Hutchins. Ms.
Boyle is a vice president of 30 investment companies for
which Mitchell Hutchins or PaineWebber serves as
investment adviser.
Donald R. Jones; 35 Vice President Mr. Jones is a first vice president and a portfolio
manager of Mitchell Hutchins. Prior to February 1996, he
was a vice president in the asset management group of
First Fidelity Bancorporation. Mr. Jones is a vice
president of two investment companies for which Mitchell
Hutchins or PaineWebber serves as investment adviser.
Thomas J. Libassi; 37 Vice President Mr. Libassi is a senior vice president and a portfolio
manager of Mitchell Hutchins. Prior to May 1994, he was
a vice president of Keystone Custodian Funds Inc. with
portfolio management responsibility. Mr. Libassi is a
vice president of four investment companies for which
Mitchell Hutchins serves as investment adviser.
C. William Maher; 35 Vice President and Mr. Maher is a first vice president and a senior manager
Assistant Treasurer of the mutual fund finance division of Mitchell
Hutchins. Mr. Maher is a vice president and assistant
treasurer of 30 investment companies for which Mitchell
Hutchins or PaineWebber serves as investment adviser.
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE WITH THE TRUST OTHER DIRECTORSHIPS
- -------------------------------- ------------------------- ----------------------------------------------------------
<S> <C> <C>
Dennis McCauley; 49 Vice President Mr. McCauley is a managing director and chief investment
officer--fixed income of Mitchell Hutchins. Prior to
December 1994, he was director of fixed income
investments of IBM Corporation. Mr. McCauley is a vice
president of 19 investment companies for which Mitchell
Hutchins or PaineWebber serves as investment adviser.
Ann E. Moran; 38 Vice President and Ms. Moran is a vice president of Mitchell Hutchins. Ms.
Assistant Treasurer Moran is a vice president and assistant treasurer of 30
investment companies for which Mitchell Hutchins or
PaineWebber serves as investment adviser.
Dianne E. O'Donnell; 43 Vice President and Ms. O'Donnell is a senior vice president and deputy
Secretary general counsel of Mitchell Hutchins. Ms. O'Donnell is a
vice president and secretary of 29 investment companies
for which Mitchell Hutchins or PaineWebber serves as
investment adviser.
Victoria E. Schonfeld; 45 Vice President Ms. Schonfeld is a managing director and general counsel
of Mitchell Hutchins. Prior to May 1994, she was a
partner in the law firm of Arnold & Porter. Ms.
Schonfeld is a vice president of 30 investment companies
for which Mitchell Hutchins or PaineWebber serves as
investment adviser.
Paul H. Schubert; 33 Vice President and Mr. Schubert is a first vice president and a senior
Assistant Treasurer manager of the mutual fund finance division of Mitchell
Hutchins. From August 1992 to August 1994, he was a vice
president at BlackRock Financial Management L.P. Prior
to August 1992, he was an audit manager with Ernst &
Young LLP. Mr. Schubert is a vice president and
assistant treasurer of 30 investment companies for which
Mitchell Hutchins or PaineWebber serves as investment
adviser.
Nirmal Singh; 39 Vice President Mr. Singh is a first vice president and a portfolio
manager of Mitchell Hutchins. Prior to September 1993,
he was a member of the portfolio management team at
Merrill Lynch Asset Management, Inc. Mr. Singh is a vice
president of five investment companies for which
Mitchell Hutchins or PaineWebber serves as investment
adviser.
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
POSITION BUSINESS EXPERIENCE;
NAME AND ADDRESS*; AGE WITH THE TRUST OTHER DIRECTORSHIPS
- -------------------------------- ------------------------- ----------------------------------------------------------
<S> <C> <C>
Julian F. Sluyters; 35 Vice President and Mr. Sluyters is a senior vice president and the director
Treasurer of the mutual fund finance division of Mitchell
Hutchins. Prior to 1991, he was an audit senior manager
with Ernst & Young LLP. Mr. Sluyters is a vice president
and treasurer of 30 investment companies for which
Mitchell Hutchins or PaineWebber serves as investment
adviser.
Mark A. Tincher; 40 Vice President Mr. Tincher is a managing director and chief investment
officer--U.S. equity investments of Mitchell Hutchins.
Prior to March 1995, he was a vice president and
directed the U.S. funds management and equity research
areas of Chase Manhattan Private Bank. Mr. Tincher is a
vice president of 14 investment companies for which
Mitchell Hutchins or PaineWebber serves as investment
adviser.
Craig M. Varrelman; 37 Vice President Mr. Varrelman is a first vice president and a portfolio
manager of Mitchell Hutchins. Mr. Varrelman is a vice
president of five investment companies for which
Mitchell Hutchins or PaineWebber serves as investment
adviser.
Stuart Waugh; 40 Vice President Mr. Waugh is a managing director and a portfolio manager
of Mitchell Hutchins responsible for global fixed income
investments and currency trading. Mr. Waugh is a vice
president of five investment companies for which
Mitchell Hutchins or PaineWebber serves as investment
adviser.
Keith A. Weller; 34 Vice President and Mr. Weller is a first vice president and associate general
Assistant Secretary counsel of Mitchell Hutchins. Prior to May 1995, he was
an attorney in private practice. Mr. Weller is a vice
president and assistant secretary of 29 investment
companies for which Mitchell Hutchins or PaineWebber
serves as investment adviser.
</TABLE>
- ------------
* Unless otherwise indicated, the business address of each listed person is
1285 Avenue of the Americas, New York, New York 10019.
** Mrs. Alexander, Mr. Bewkes and Ms. Farrell are 'interested persons' of the
Trust as defined in the 1940 Act by virtue of their positions with PW Group,
PaineWebber and/or Mitchell Hutchins.
The Trust pays trustees who are not 'interested persons' of the Trust
$1,000 annually for each series and $150 for each board meeting and each
separate meeting of a board committee. The Trust presently has two series and
thus pays each such trustee $2,000 annually, plus any additional amounts due for
board or committee meetings. Certain committee chairs receive additional
compensation aggregating $15,000 annually from all the funds within the
PaineWebber fund complex. Trustees of the Trust who are 'interested persons'
receive no compensation from the Trust. All trustees are reimbursed for any
expenses incurred in attending meetings. Trustees and officers of the Trust own
in the aggregate less than 1% of the shares of the Fund.
25
<PAGE>
Because Mitchell Hutchins and PaineWebber perform substantially all of the
services necessary for the operation of the Trust and the Fund, the Trust
requires no employees. No officer, director or employee of Mitchell Hutchins or
PaineWebber presently receives any compensation from the Trust for acting as a
trustee or officer.
The table below includes certain information relating to the compensation
of the Trust's current trustees who held office with the Trust or other
PaineWebber funds during the fiscal year ended January 31, 1996.
<TABLE>
<CAPTION>
COMPENSATION TABLE
TOTAL
COMPENSATION
FROM THE
TRUST AND
AGGREGATE THE TRUST
COMPENSATION COMPLEX PAID
FROM TO
NAME OF PERSON, POSITION THE TRUST* TRUSTEES**
- --------------------------------------------- ------------ ------------
<S> <C> <C>
Richard Q. Armstrong, Trustee................ $1,563 $ 9,000
Richard R. Burt, Trustee..................... 750 7,750
Meyer Feldberg, Trustee...................... -- 106,375
George W. Gowen, Trustee..................... -- 99,750
Frederic V. Malek, Trustee................... -- 99,750
Carl W. Schafer, Trustee..................... -- 118,175
John R. Torell III, Trustee.................. 2,563 28,125
</TABLE>
- ------------
Only independent members of the board of trustees are compensated by the Trust
and identified above; trustees who are 'interested persons,' as defined by the
1940 Act, do not receive compensation.
* Represents fees paid to each trustee during the fiscal year ended January 31,
1996; the Trust does not have a pension or retirement plan.
** Represents total compensation paid to each trustee during the calendar year
ended December 31, 1995.
INVESTMENT ADVISORY AND DISTRIBUTION ARRANGEMENTS
INVESTMENT ADVISORY ARRANGEMENTS. Mitchell Hutchins acts as the investment
adviser and administrator of the Fund pursuant to a contract dated January 28,
1993, as supplemented by a Fee Agreement dated January 28, 1994, with the Trust
('Advisory Contract'). Under the Advisory Contract, the Fund pays Mitchell
Hutchins a fee of 0.75%, computed daily and paid monthly. For the fiscal year
ended January 31, 1996 and the fiscal period February 7, 1994 (commencement of
operations) through January 31, 1995, the Fund paid (or accrued) to Mitchell
Hutchins investment advisory and administration fees of $546,119 and $603,811,
respectively.
Under a service agreement with the Trust, PaineWebber provides certain
services not otherwise provided by the Fund's transfer agent. The agreement is
reviewed by the Trust's board of trustees annually. During fiscal year ended
January 31, 1996 and the fiscal period February 7, 1994 (commencement of
operations) through January 31, 1995, the Fund paid (or accrued) to PaineWebber
service fees of $19,823 and $21,998, respectively.
Under the terms of the Advisory Contract, the Fund bears all expenses
incurred in its operation that are not specifically assumed by Mitchell
Hutchins. Expenses borne by the Fund include the following: (1) the cost
(including brokerage commissions) of securities purchased or sold by the Fund
and any losses incurred in connection therewith; (2) fees payable to and
expenses incurred on behalf of the Fund by Mitchell Hutchins; (3) organizational
expenses; (4) filing fees and expenses relating to the registration and
qualification of the Fund's shares under federal and state securities laws and
maintenance of such registrations and qualifications; (5) fees and salaries
payable to trustees and officers who are not interested persons (as
26
<PAGE>
defined in the 1940 Act) of the Fund or Mitchell Hutchins; (6) all expenses
incurred in connection with the trustees' services, including travel expenses;
(7) taxes (including any income or franchise taxes) and governmental fees; (8)
costs of any liability, uncollectable items of deposit and other insurance or
fidelity bonds; (9) any costs, expenses or losses arising out of a liability of
or claim for damages or other relief asserted against the Trust or the Fund for
violation of any law; (10) legal, accounting and auditing expenses, including
legal fees of special counsel for the independent trustees; (11) charges of
custodians, transfer agents and other agents; (12) costs of preparing share
certificates; (13) expenses of setting in type and printing prospectuses,
statements of additional information and supplements thereto, reports and proxy
materials for existing shareholders, and costs of mailing such materials to
shareholders; (14) any extraordinary expenses (including fees and disbursements
of counsel) incurred by the Fund; (15) fees, voluntary assessments and other
expenses incurred in connection with membership in investment company
organizations; (16) costs of mailing and tabulating proxies and costs of
meetings of shareholders, the board and any committees thereof; (17) the cost of
investment company literature and other publications provided to trustees and
officers and (18) costs of mailing, stationery and communications equipment.
As required by state regulation, Mitchell Hutchins will reimburse the Fund
if and to the extent that the aggregate operating expenses of the Fund in any
fiscal year exceed applicable limits. Currently, the most restrictive such limit
applicable to the Fund is 2.5% of the first $30 million of the Fund's average
daily net assets, 2.0% of the next $70 million of its average daily net assets
and 1.5% of its average daily net assets in excess of $100 million. Certain
expenses, such as brokerage commissions, taxes, interest, distribution fees,
certain expenses attributable to investing outside the United States and
extraordinary items, are excluded from this limitation. No reimbursement
pursuant to this limitation was required for the fiscal year ended January 31,
1996 and the fiscal period February 7, 1994 (commencement of operations) to
January 31, 1995.
Under the Advisory Contract, Mitchell Hutchins will not be liable for any
error of judgment or mistake of law or for any loss suffered by the Fund in
connection with the performance of the Advisory Contract, except a loss
resulting from willful misfeasance, bad faith or gross negligence on the part of
Mitchell Hutchins in the performance of its duties or from reckless disregard of
its duties and obligations thereunder. The Advisory Contract terminates
automatically upon assignment and is terminable at any time without penalty by
the board of trustees or by vote of the holders of a majority of the Fund's
outstanding voting securities on 60 days' written notice to Mitchell Hutchins,
or by Mitchell Hutchins on 60 days' written notice to the Fund.
The following table shows the approximate net assets as of April 30, 1996,
sorted by category of investment objective, of the investment companies as to
which Mitchell Hutchins serves as adviser or sub-adviser. An investment company
may fall into more than one of the categories below.
<TABLE>
<CAPTION>
NET
ASSETS
INVESTMENT CATEGORY ($ MIL)
-------------------------------------------------- ---------
<S> <C>
Domestic (excluding Money Market)................. $ 5,589.0
Global............................................ 2,851.3
Equity/Balanced................................... 3,052.1
Fixed Income (excluding Money Market)............. 5,388.2
Taxable Fixed Income......................... 3,736.1
Tax-Free Fixed Income........................ 1,652.1
Money Market Funds................................ 21,751.2
</TABLE>
Mitchell Hutchins personnel may invest in securities for their own accounts
pursuant to a code of ethics that describes the fiduciary duty owed to
shareholders of the PaineWebber mutual funds and other Mitchell Hutchins'
advisory accounts by all Mitchell Hutchins' directors, officers and employees,
establishes procedures for personal investing and restricts certain
transactions. For example, employee accounts generally must be maintained at
PaineWebber, personal trades in most securities require pre-clearance and
short-term trading and participation in initial public offerings generally are
prohibited. In addition,
27
<PAGE>
the code of ethics puts restrictions on the timing of personal investing in
relation to trades by PaineWebber mutual funds and other Mitchell Hutchins
advisory clients.
DISTRIBUTION ARRANGEMENTS. Mitchell Hutchins acts as the distributor of the
Class A, Class B and Class C shares of the Fund under separate distributions
contracts with the Trust dated January 28, 1993 or November 10, 1995
(collectively, 'Distribution Contracts') that require Mitchell Hutchins to use
its best efforts, consistent with its other businesses, to sell shares of the
Fund. Shares of the Fund are offered continuously. Under separate exclusive
dealer agreements between Mitchell Hutchins and PaineWebber dated January 28,
1993 or November 10, 1995 relating to the Class A, Class B and Class C shares of
the Fund (collectively, 'Exclusive Dealer Agreements'), PaineWebber and its
correspondent firms sell the Fund's shares.
Under separate plans of distribution pertaining to the Class A, Class B
and Class C shares of the Fund adopted by the Trust in the manner prescribed
under Rule 12b-1 under the 1940 Act ('Class A Plan,' 'Class B Plan' and 'Class C
Plan,' collectively, 'Plans'), the Fund pays Mitchell Hutchins a service fee,
accrued daily and payable monthly, at the annual rate of 0.25% of the average
daily net assets of each Class of shares. Under the Class B Plan, the Fund also
pays Mitchell Hutchins a distribution fee, accrued daily and payable monthly, at
the annual rate of 0.75% of the average daily net assets of the Class B shares.
Under the Class C Plan, the Fund pays Mitchell Hutchins a distribution fee,
accrued daily and payable monthly, at the annual rate of 0.50% of the average
daily net assets of the Class C shares.
Among other things, each Plan provides that (1) Mitchell Hutchins will
submit to the Trust's board of trustees at least quarterly, and the trustees
will review, reports regarding all amounts expended under the Plan and the
purposes for which such expenditures were made, (2) the Plan will continue in
effect only so long as it is approved at least annually, and any material
amendment thereto is approved, by the Trust's board of trustees, including those
trustees who are not 'interested persons' of the Trust and who have no direct or
indirect financial interest in the operation of the Plan or any agreement
related to the Plan, acting in person at a meeting called for that purpose, (3)
payments by the Fund under the Plan shall not be materially increased without
the affirmative vote of the holders of a majority of the outstanding shares of
the relevant class and (4) while the Plan remains in effect, the selection and
nomination of trustees who are not 'interested persons' of the Trust shall be
committed to the discretion of the trustees who are not 'interested persons' of
the Trust.
In reporting amounts expended under the Plans to the trustees, Mitchell
Hutchins will allocate expenses attributable to the sale of each Class of Fund
shares to such Class based on the ratio of sales of shares of such Class to the
sales of all three Classes of shares. The fees paid by one Class of Fund shares
will not be used to subsidize the sale of any other Class of Fund shares.
For the fiscal year ended January 31, 1996, the Fund paid (or accrued) the
following fees to Mitchell Hutchins under the Plans.
<TABLE>
<S> <C>
Class A................................. $ 25,887
Class B................................. $ 415,659
Class C................................. $ 156,716
</TABLE>
28
<PAGE>
Mitchell Hutchins estimates that it and its parent corporation,
PaineWebber, incurred the following shareholder service-related and
distribution-related expenses with respect to the Fund during the fiscal year
ended January 31, 1996:
<TABLE>
<CAPTION>
CLASS A
<S> <C>
Marketing and advertising................................... $ 57,841
Printing of prospectuses and statements of additional
information............................................... 347
Branch network costs allocated and interest expense......... 25,190
Service fees paid to PaineWebber investment executives...... 11,649
<CAPTION>
CLASS B
<S> <C>
Marketing and advertising................................... $ 271,864
Amortization of commissions................................. 147,793
Printing of prospectuses and statements of additional
information............................................... 1,629
Branch network costs allocated and interest expense......... 149,592
Service fees paid to PaineWebber investment executives...... 46,762
<CAPTION>
CLASS C
<S> <C>
Marketing and advertising................................... $ 129,542
Amortization of commissions................................. 41,673
Printing of prospectuses and statements of additional
information............................................... 777
Branch network costs allocated and interest expense......... 56,752
Service fees paid to PaineWebber investment executives...... 17,631
</TABLE>
'Marketing and advertising' includes various internal costs allocated by
Mitchell Hutchins to its efforts at distributing Fund shares. These internal
costs encompass office rent, salaries and other overhead expenses of various
departments and areas of operations of Mitchell Hutchins. 'Branch network costs
allocated and interest expense' consist of an allocated portion of the expenses
of various PaineWebber departments involved in the distribution of the Fund's
shares, including the PaineWebber retail branch system.
In approving the Fund's overall Flexible Pricing (Service Mark) system of
distribution, the Trust's board of trustees considered several factors,
including that implementation of Flexible Pricing would (1) enable investors to
choose the purchasing option best suited to their individual situation, thereby
encouraging current shareholders to make additional investments in the Fund and
attracting new investors and assets to the Fund to the benefit of the Fund and
its shareholders, (2) facilitate distribution of the Fund's shares and (3)
maintain the competitive position of the Fund in relation to other funds that
have implemented or are seeking to implement similar distribution arrangements.
In approving the Class A Plan for the Fund, the trustees considered all the
features of the distribution system, including (1) the conditions under which
initial sales charges would be imposed and the amount of such charges, (2)
Mitchell Hutchins' belief that the initial sales load combined with a service
fee would be attractive to PaineWebber investment executives and correspondent
firms, resulting in a greater growth of the Fund than might otherwise be the
case, (3) the advantages to the shareholders of economies of scale resulting
from growth in the Fund's assets and potential continued growth, (4) the
services provided to the Fund and its shareholders by Mitchell Hutchins, (5) the
services provided by PaineWebber pursuant to its Exclusive Dealer Agreement with
Mitchell Hutchins and (6) Mitchell Hutchins' shareholder service-related
expenses and costs.
In approving the Class B Plan for the Fund, the trustees considered all the
features of the distribution system, including (1) the conditions under which
contingent deferred sales charges would be imposed and the amount of such
charges, (2) the advantage to investors in having no initial sales charges
deducted from Fund purchase payments and instead having the entire amount of
their purchase payments immediately invested in Fund shares, (3) Mitchell
Hutchins' belief that the ability of
29
<PAGE>
PaineWebber investment executives and correspondent firms to receive sales
commissions when Class B shares are sold and continuing service fees thereafter
while their customers invest their entire purchase payments immediately in Class
B shares would prove attractive to the investment executives and correspondent
firms, resulting in greater growth of the Fund than might otherwise be the case;
(4) the advantages to the shareholders of economies of scale resulting from
growth in the Fund's assets and potential continued growth, (5) the services
provided to the Fund and its shareholders by Mitchell Hutchins, (6) the services
provided by PaineWebber pursuant to its Exclusive Dealer Agreement with Mitchell
Hutchins and (7) Mitchell Hutchins' shareholder service- and
distribution-related expenses and costs. The trustees also recognized that
Mitchell Hutchins' willingness to compensate PaineWebber and its investment
executives, without the concomitant receipt by Mitchell Hutchins of initial
sales charges, was conditioned upon its expectation of being compensated under
the Class B Plan.
In approving the Class C Plan for the Fund, the trustees considered all the
features of the distribution system, including (1) the advantage to investors in
having no initial sales charges deducted from Fund purchase payments and instead
having the entire amount of their purchase payments immediately invested in Fund
shares, (2) the advantage to investors in being free from contingent deferred
sales charges upon redemption for shares held more than one year and paying for
distribution on an ongoing basis, (3) Mitchell Hutchins' belief that the ability
of PaineWebber investment executives and correspondent firms to receive sales
compensation for their sales of Class C shares on an ongoing basis, along with
continuing service fees, while their customers invest their entire purchase
payments immediately in Class C shares without facing contingent deferred sales
charges, would prove attractive to the investment executives and correspondent
firms, resulting in greater growth of the Fund than might otherwise be the case,
(4) the advantages to the shareholders of economies of scale resulting from
growth in the Fund's assets and potential continued growth, (5) the services
provided to the Fund and its shareholders by Mitchell Hutchins, (6) the services
provided by PaineWebber pursuant to its Exclusive Dealer Agreement with Mitchell
Hutchins and (7) Mitchell Hutchins' shareholder service- and
distribution-related expenses and costs. The trustees also recognized that
Mitchell Hutchins' willingness to compensate PaineWebber and its investment
executives, without the concomitant receipt by Mitchell Hutchins of initial
sales charges or contingent deferred sales charges upon redemption of shares
held more than one year, was conditioned upon its expectation of being
compensated under the Class C Plan.
With respect to each Plan, the trustees considered all compensation that
Michell Hutchins would receive under the Plan and the Distribution Contract,
including service fees and, as applicable, initial sales charges, distribution
fees and contingent deferred sales charges. The trustees also considered the
benefits that would accrue to Mitchell Hutchins under each Plan in that Mitchell
Hutchins would receive service, distribution and advisory fees that are
calculated based upon a percentage of the average net assets of the Fund, which
fees would increase if the Plan were successful and the Fund attained and
maintained significant asset levels.
Under the Distribution Contract for the Class A shares, for the periods set
forth below, Mitchell Hutchins earned the following approximate amounts of sales
charges and retained the following approximate amounts, net of concessions to
PaineWebber as exclusive dealer.
<TABLE>
<CAPTION>
PERIOD FEBRUARY 7, 1994
FISCAL YEAR ENDED (COMMENCEMENT OF OPERATIONS)
JANUARY 31, 1996 TO JANUARY 31, 1995
----------------- ----------------------------
<S> <C> <C>
Earned.................................. $ 7,392 $469,876
Retained................................ $ 415 $ 32,555
</TABLE>
For the fiscal year ended January 31, 1996, Mitchell Hutchins earned and
retained the following contingent deferred sales charges paid upon certain
redemptions of Class A, Class B and Class C shares:
<TABLE>
<S> <C>
Class A........................................... $ 0
Class B........................................... $ 44,780
Class C........................................... $ 0
</TABLE>
30
<PAGE>
PORTFOLIO TRANSACTIONS
Subject to policies established by the board of trustees, Mitchell Hutchins
is responsible for the execution of the Fund's portfolio transactions and the
allocation of brokerage transactions. In executing portfolio transactions,
Mitchell Hutchins seeks to obtain the best net results for the Fund, taking into
account such factors as the price (including the applicable brokerage commission
or dealer spread), size of the order, difficulty of execution and operational
facilities of the firm involved. While Mitchell Hutchins generally seeks
reasonably competitive commission rates, payment of the lowest commission is not
necessarily consistent with obtaining the best net results. Generally, fixed
income securities are traded on the OTC market on a 'net' basis without a stated
commission through dealers acting for their own account and not as brokers.
Prices paid to dealers generally include a 'spread,' which is the difference
between the prices at which the dealer is willing to purchase and sell a
specific security at the time. The Fund has paid no brokerage commissions since
its inception.
The Fund has no obligation to deal with any broker or group of brokers in
the execution of portfolio transactions. The Fund contemplates that, consistent
with obtaining the best net results, brokerage transactions may be conducted
through Mitchell Hutchins or any of its affiliates, including PaineWebber. The
Trust's board of trustees has adopted procedures in conformity with Rule 17e-1
under the 1940 Act to ensure that all brokerage commissions paid to Mitchell
Hutchins or any of its affiliates are reasonable and fair. Specific provisions
in the Advisory Contract authorize Mitchell Hutchins and any affiliate thereof
which is a member of a national securities exchange to effect portfolio
transactions for the Fund on such exchange and to retain compensation in
connection with such transactions. Any such transactions will be effected and
related compensation paid only in accordance with applicable SEC regulations.
The Fund has paid no brokerage commissions to PaineWebber since its inception.
Transactions in futures contracts are executed through futures commission
merchants ('FCMs'). The Fund's procedures in selecting FCMs to execute the
Fund's transactions in futures contracts, including procedures permitting the
use of Mitchell Hutchins and its affiliates, are similar to those in effect with
respect to brokerage transactions in securities.
Consistent with the Fund's interests and subject to the review of the
Trust's board of trustees, Mitchell Hutchins may cause the Fund to purchase and
sell portfolio securities from and to dealers, or through brokers, which provide
the Fund with research, analysis, advice and similar services. In return for
such services, the Fund may pay to those brokers a higher commission than may be
charged by other brokers, provided that Mitchell Hutchins determines in good
faith that such commission is reasonable in terms either of that particular
transaction or of the overall responsibility of Mitchell Hutchins to the Fund
and its other clients and that the total commissions paid by the Fund will be
reasonable in relation to the benefits to the Fund over the long term. During
the fiscal year ended January 31, 1996, the Fund directed no portfolio
transactions to brokers chosen because they provided research services.
Portfolio transactions will not be directed by the Fund to dealers solely
on the basis of research services provided. For purchases or sales with
broker-dealer firms which act as principal, Mitchell Hutchins seeks best
execution. Although Mitchell Hutchins may receive certain research or execution
services in connection with these transactions, Mitchell Hutchins will not
purchase securities at a higher price or sell securities at a lower price than
would otherwise be paid if no weight was attributed to the services provided by
the executing dealer. Moreover, Mitchell Hutchins will not enter into any
explicit soft dollar arrangements relating to principal transactions and will
not receive in principal transactions the types of services which could be
purchased for hard dollars. Mitchell Hutchins may engage in agency transactions
in OTC equity and debt securities in return for research and execution services.
These transactions are entered into only in compliance with procedures ensuring
that the transaction (including commissions) is at least as favorable as it
would have been if effected directly with a market-maker that did not provide
research or execution
31
<PAGE>
services. These procedures include Mitchell Hutchins receiving multiple quotes
from dealers before executing the transactions on an agency basis.
Research services furnished by dealers or brokers with or through which the
Fund effects securities transactions may be used by Mitchell Hutchins in
advising other funds or accounts and, conversely, research services furnished to
Mitchell Hutchins by dealers or brokers in connection with other funds or
accounts Mitchell Hutchins advises may be used by Mitchell Hutchins in advising
the Fund. Information and research received from such brokers or dealers will be
in addition to, and not in lieu of, the services required to be performed by
Mitchell Hutchins under the Advisory Contract.
Investment decisions for the Fund and for other investment accounts managed
by Mitchell Hutchins will be made independently of each other in the light of
differing considerations for the various accounts. The same investment decision,
however, may occasionally be made for the Fund and one or more of such accounts.
In such cases, simultaneous transactions are inevitable. Purchases or sales are
then averaged as to price and allocated between the Fund and such other
account(s) as to amount according to a formula deemed equitable to the Fund and
such account(s). While in some cases this practice could have a detrimental
effect upon the price or value of the security as far as the Fund is concerned
or upon its ability to complete its entire order, in other cases it is believed
that coordination and the ability to participate in volume transactions will be
beneficial to the Fund.
The Fund will not purchase securities that are offered in underwritings in
which Mitchell Hutchins or any of its affiliates is a member of the underwriting
or selling group except pursuant to the procedures adopted by the Trust's board
of trustees in conformity with Rule 10f-3 under the 1940 Act. Among other
things, these procedures require that the commission or spread paid in
connection with such a purchase be reasonable and fair, that the purchase be at
not more than the public offering price prior to the end of the first business
day after the date of the public offering and that Mitchell Hutchins and its
affiliates not participate in or benefit from the sale to the Fund.
PORTFOLIO TURNOVER
Portfolio turnover may vary greatly from year to year and will not be a
limiting factor when Mitchell Hutchins deems portfolio changes appropriate. A
higher turnover rate may involve correspondingly greater transaction costs,
which will be borne directly by the Fund. The Fund's annual portfolio turnover
rate will be calculated by dividing the lesser of the Fund's annual sales or
purchases of portfolio securities (exclusive of purchases or sales of securities
whose maturities at the time of acquisition were one year or less) by the
monthly average value of the long-term securities in the portfolio during the
year. During the fiscal year ended January 31, 1996 and the fiscal period
February 7, 1994 (commencement of operations) through January 31, 1995, the
portfolio turnover rate was 91% and 117%, respectively.
REDUCED SALES CHARGES, ADDITIONAL EXCHANGE AND REDEMPTION
INFORMATION AND OTHER SERVICES
COMBINED PURCHASE PRIVILEGE--CLASS A SHARES. Investors and eligible groups
of related Fund investors may combine purchases of Class A shares of the Fund
with concurrent purchases of Class A shares of any other PaineWebber mutual fund
and thus take advantage of the reduced sales charges indicated in the table of
sales charges for Class A shares in the Prospectus. The sales charge payable on
the purchase of Class A shares of the Fund and Class A shares of such other
funds will be at the rates applicable to the total amount of the combined
concurrent purchases.
32
<PAGE>
An 'eligible group of related Fund investors' can consist of any
combination of the following:
(a) an individual, that individual's spouse, parents and children;
(b) an individual and his or her Individual Retirement Account
('IRA');
(c) an individual (or eligible group of individuals) and any company
controlled by the individual(s) (a person, entity or group that holds 25%
or more of the outstanding voting securities of a corporation will be
deemed to control the corporation, and a partnership will be deemed to be
controlled by each of its general partners);
(d) an individual (or eligible group of individuals) and one or more
employee benefit plans of a company controlled by the individual(s);
(e) an individual (or eligible group of individuals) and a trust
created by the individual(s), the beneficiaries of which are the individual
and/or the individual's spouse, parents or children;
(f) an individual and a Uniform Gifts to Minors Act/Uniform Transfers
to Minors Act account created by the individual or the individual's spouse;
(g) an employer (or group of related employers) and one or more
qualified retirement plans of such employer or employers (an employer
controlling, controlled by or under common control with another employer is
deemed related to that other employer); or
(h) individual accounts related together under one registered
investment adviser having full discretion and control over the accounts.
The registered investment adviser must communicate at least through a
newsletter or investment update establishing a relationship with all of the
accounts.
RIGHTS OF ACCUMULATION--CLASS A SHARES. Reduced sales charges are
available through a right of accumulation, under which investors and eligible
groups of related Fund investors (as defined above) are permitted to purchase
Class A shares of the Fund among related accounts at the offering price
applicable to the total of (1) the dollar amount then being purchased plus (2)
an amount equal to the then-current net asset value of the purchaser's combined
holdings of Class A Fund shares and Class A shares of any other PaineWebber
mutual fund. The purchaser must provide sufficient information to permit
confirmation of his or her holdings, and the acceptance of the purchase order is
subject to such confirmation. The right of accumulation may be amended or
terminated at any time.
WAIVERS OF SALES CHARGES--CLASS B SHARES. Among other circumstances, the
contingent deferred sales charge on Class B shares is waived where a total or
partial redemption is made within one year following the death of the
shareholder. The contingent deferred sales charge waiver is available where the
decedent is either the individual shareholder or owns the shares with his or her
spouse as a joint tenant with right of survivorship. This waiver applies only to
redemption of shares held at the time of death.
Certain PaineWebber mutual funds offered shares subject to contingent
deferred sales charges before the implementation of the Flexible Pricing System
on July 1, 1991 ('CDSC Funds'). The contingent deferred sales charge is waived
with respect to redemptions of Class B shares of CDSC Funds purchased prior to
July 1, 1991 by officers, directors (trustees) or employees of the CDSC Funds,
Mitchell Hutchins or their affiliates (or their spouses and children under age
21). In addition, the contingent deferred sales charge will be reduced by 50%
with respect to redemptions of Class B shares of CDSC Funds purchased prior to
July 1, 1991 with a net asset value at the time of purchase of at least $1
million. If Class B shares of a CDSC Fund purchased prior to July 1, 1991 are
exchanged for Class B shares of the Fund, any waiver or reduction of the
contingent deferred sales charge that applied to the Class B Shares of the CDSC
Fund will apply to the Class B shares of the Fund acquired through the exchange.
33
<PAGE>
ADDITIONAL EXCHANGE AND REDEMPTION INFORMATION. As discussed in the
Prospectus, eligible shares of the Fund may be exchanged for shares of the
corresponding Class of most other PaineWebber mutual funds. Shareholders will
receive at least 60 days' notice of any termination or material modification of
the exchange offer, except no notice need be given of an amendment whose only
material effect is to reduce the exchange fee and no notice need be given if,
under extraordinary circumstances, either redemptions are suspended under the
circumstances described below or the Fund temporarily delays or ceases the sales
of its shares because it is unable to invest amounts effectively in accordance
with the Fund's investment objectives, policies and restrictions.
If conditions exist that make cash payments undesirable, the Fund reserves
the right to honor any request for redemption by making payment in whole or in
part in securities chosen by the Fund and valued in the same way as they would
be valued for purposes of computing the Fund's net asset value. If payment is
made in securities, a shareholder may incur brokerage expenses in converting
these securities into cash. The Trust has elected, however, to be governed by
Rule 18f-1 under the 1940 Act, under which the Fund is obligated to redeem
shares solely in cash up to the lesser of $250,000 or 1% of the net asset value
of the Fund during any 90-day period for one shareholder. This election is
irrevocable unless the SEC permits its withdrawal. The Fund may suspend
redemption privileges or postpone the date of payment during any period (1) when
the NYSE is closed or trading on the NYSE is restricted as determined by the
SEC, (2) when an emergency exists, as defined by the SEC, that makes it not
reasonably practicable for the Fund to dispose of securities owned by it or
fairly to determine the value of its assets or (3) as the SEC may otherwise
permit. The redemption price may be more or less than the shareholder's cost,
depending on the market value of the Fund's portfolio at the time.
SYSTEMATIC WITHDRAWAL PLAN. On or about the 15th of each month for monthly
plans and on or about the 15th of the months selected for quarterly or
semi-annual plans, PaineWebber will arrange for redemption by the Fund of
sufficient Fund shares to provide the withdrawal payment specified by
participants in the Fund's systematic withdrawal plan. The payment generally is
mailed approximately five Business Days after the redemption date. Withdrawal
payments should not be considered dividends, but redemption proceeds, with the
tax consequences described under 'Dividends and Taxes' in the Prospectus. If
periodic withdrawals continually exceed reinvested dividends, a shareholder's
investment may be correspondingly reduced. A shareholder may change the amount
of the systematic withdrawal or terminate participation in the systematic
withdrawal plan at any time without charge or penalty by written instructions
with signatures guaranteed to PaineWebber or PFPC Inc. ('Transfer Agent').
Instructions to participate in the plan, change the withdrawal amount or
terminate participation in the plan will not be effective until five days after
written instructions with signatures guaranteed are received by the Transfer
Agent. Shareholders may request the forms needed to establish a systematic
withdrawal plan from their PaineWebber investment executives, correspondent
firms or the Transfer Agent at 1-800-647-1568.
REINSTATEMENT PRIVILEGE--CLASS A SHARES. As described in the Prospectus,
shareholders who have redeemed their Class A shares may reinstate their account
in the Fund without a sales charge. Shareholders may exercise the reinstatement
privilege by notifying the Transfer Agent of such desire and forwarding a check
for the amount to be purchased within 365 days after the date of redemption. The
reinstatement will be made at the net asset value per share next computed after
the notice of reinstatement and check are received. The amount of a purchase
under this reinstatement privilege cannot exceed the amount of the redemption
proceeds. Gain on a redemption is taxable regardless of whether the
reinstatement privilege is exercised; however, a loss arising out of a
redemption will not be deductible to the extent the redemption proceeds are
reinvested within 30 days after redemption, and an adjustment will be made to
the shareholder's tax basis for shares acquired pursuant to the reinstatement
privilege. Gain or loss on a redemption also will be adjusted for federal income
tax purposes by the amount of any sales charge paid on Class A shares, under the
circumstances and to the extent described in 'Dividends and Taxes' in the
Prospectus.
34
<PAGE>
PAINEWEBBER RMA RESOURCE ACCUMULATION PLAN (Service Mark)
PAINEWEBBER RESOURCE MANAGEMENT ACCOUNT(REGISTERED) (RMA(REGISTERED))
Shares of the PaineWebber mutual funds (each a 'PW Fund' and, collectively,
the 'PW Funds') are available for purchase through the RMA Resource Accumulation
Plan ('Plan') by customers of PaineWebber and its correspondent firms who
maintain Resource Management Accounts ('RMA accountholders'). The Plan allows an
RMA accountholder to continually invest in one or more of the PW Funds at
regular intervals, with payment for shares purchased automatically deducted from
the client's RMA account. The client may elect to invest at monthly or quarterly
intervals and may elect either to invest a fixed dollar amount (minimum $100 per
period) or to purchase a fixed number of shares. A client can elect to have Plan
purchases executed on the first or fifteenth day of the month. Settlement occurs
three Business Days after the trade date, and the purchase price of the shares
is withdrawn from the investor's RMA account on the settlement date from the
following sources and in the following order: uninvested cash balances, balances
in RMA money market funds, or margin borrowing power, if applicable to the
account.
To participate in the Plan, an investor must be an RMA accountholder, must
have made an initial purchase of the shares of each PW Fund selected for
investment under the Plan (meeting applicable minimum investment requirements)
and must complete and submit the RMA Resource Accumulation Plan Client Agreement
and Instruction Form available from PaineWebber. The investor must have received
a current prospectus for each PW Fund selected prior to enrolling in the Plan.
Information about mutual fund positions and outstanding instructions under the
Plan are noted on the RMA accountholder's account statement. Instructions under
the Plan may be changed at any time, but may take up to two weeks to become
effective.
The terms of the Plan or an RMA accountholder's participation in the Plan
may be modified or terminated at any time. It is anticipated that, in the
future, shares of other PW Funds and/or mutual funds other than the PW Funds may
be offered through the Plan.
PERIODIC INVESTING AND DOLLAR COST AVERAGING. Periodic investing in the PW
Funds or other mutual funds, whether through the Plan or otherwise, helps
investors establish and maintain a disciplined approach to accumulating assets
over time, de-emphasizing the importance of timing the market's highs and lows.
Periodic investing also permits an investor to take advantage of 'dollar cost
averaging.' By investing a fixed amount in mutual fund shares at established
intervals, an investor purchases more shares when the price is lower and fewer
shares when the price is higher, thereby increasing his or her earning
potential. Of course, dollar cost averaging does not guarantee a profit or
protect against a loss in a declining market, and an investor should consider
his or her financial ability to continue investing through periods of low share
prices. However, over time, dollar cost averaging generally results in a lower
average original investment cost than if an investor invested a larger dollar
amount in a mutual fund at one time.
PAINEWEBBER'S RESOURCE MANAGEMENT ACCOUNT. In order to enroll in the Plan,
an investor must have opened an RMA account with PaineWebber or one of its
correspondent firms. The RMA account is PaineWebber's comprehensive asset
management account and offers investors a number of features, including the
following:
o monthly Premier account statements that itemize all account
activity, including investment transactions, checking activity and
Gold MasterCard (R) transactions during the period, and provide
unrealized and realized gain and loss estimates for most securities
held in the account;
o comprehensive preliminary 9-month and year-end summary statements
that provide information on account activity for use in tax
planning and tax return preparation;
o automatic 'sweep' of uninvested cash into the RMA accountholder's
choice of one of the seven RMA money market funds-RMA Money Market
Portfolio, RMA U.S. Government Portfolio, RMA Tax-Free Fund, RMA
California Municipal Money Fund, RMA Connecticut Municipal Money
Fund,
35
<PAGE>
RMA New Jersey Municipal Money Fund and RMA New York Municipal
Money Fund. Each money market fund attempts to maintain a stable
price per share of $1.00, although there can be no assurance that
it will be able to do so. Investments in the money market funds are
not insured or guaranteed by the U.S. government;
o check writing, with no per-check usage charge, no minimum amount on
checks and no maximum number of checks that can be written. RMA
accountholders can code their checks to classify expenditures. All
canceled checks are returned each month;
o Gold MasterCard, with or without a line of credit,which provides
RMA accountholders with direct access to their accounts and can be
used with automatic teller machines worldwide. Purchases on the
Gold MasterCard are debited to the RMA account once monthly,
permitting accountholders to remain invested for a longer period of
time;
o 24-hour access to account information through toll-free numbers and
more detailed personal assistance during business hours from the
RMA Service Center;
o expanded account protection to $25 million in the event of the
liquidation of PaineWebber. This protection does not apply to
shares of the RMA money market funds or the PW Funds because those
shares are held at the transfer agent and not through PaineWebber;
and
o automatic direct deposit of checks into your RMA account and
automatic withdrawals from the account.
The annual account fee for an RMA account is $85, which includes the Gold
MasterCard, with an additional fee of $40 if the investor selects an optional
line of credit with the Gold MasterCard.
CONVERSION OF CLASS B SHARES
Class B shares of the Fund will automatically convert to Class A shares,
based on the relative net asset values per share of the two Classes, as of the
close of business on the first Business Day of the month in which the sixth
anniversary of the initial issuance of such Class B shares occurs. For the
purpose of calculating the holding period required for conversion of Class B
shares, the date of initial issuance shall mean (1) the date on which such Class
B shares were issued, or (2) for Class B shares obtained through an exchange, or
a series of exchanges, the date on which the original Class B shares were
issued. If the shareholder acquired Class B shares of the Fund through an
exchange of Class B shares of a CDSC Fund that were acquired prior to July 1,
1991, the shareholder's holding period for purposes of conversion will be
determined based on the date the CDSC Fund shares were initially issued. For
purposes of conversion into Class A, Class B shares purchased through the
reinvestment of dividends and other distributions paid in respect of Class B
shares will be held in a separate sub-account. Each time any Class B shares in
the shareholder's regular account (other than those in the sub-account) convert
to Class A, a pro rata portion of the Class B shares in the sub-account will
also convert to Class A. The portion will be determined by the ratio that the
shareholder's Class B shares converting to Class A bears to the shareholder's
total Class B shares not acquired through dividends and other distributions.
The availability of the conversion feature is subject to (1) the continuing
applicability of a ruling of the Internal Revenue Service that the dividends and
other distributions paid on Class A and Class B shares will not result in
'preferential dividends' under the Code and (2) the continuing availability of
an opinion of counsel to the effect that the conversion of shares does not
constitute a taxable event. If the conversion feature ceased to be available,
the Class B shares would not be converted and would continue to be subject to
the higher ongoing expenses of the Class B shares beyond six years from the date
of purchase. Mitchell Hutchins has no reason to believe that these conditions
for the availability of the conversion feature will not continue to be met.
36
<PAGE>
VALUATION OF SHARES
The Fund determines the net asset value per share separately for each Class
of shares as of the close of regular trading (currently 4:00 p.m., Eastern time)
on the NYSE on each Business Day. Currently the NYSE is closed on the observance
of the following holidays: New Year's Day, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
Securities that are listed on U.S. and foreign stock exchanges are valued
at the last sale price on the date the securities are valued or, lacking any
sales on such day, at the last available bid price. In cases where securities
are traded on more than one exchange, the securities are generally valued on the
exchange considered by Mitchell Hutchins as the primary market. Securities
traded in the OTC market and listed on the Nasdaq Stock Market ('Nasdaq') are
valued at the last trade price on Nasdaq at 4:00 p.m., Eastern time; other OTC
securities are valued at the last bid price available prior to valuation.
Futures contracts, forward currency contracts and options are valued on the
basis of market quotations, if any. Securities and assets for which market
quotations are not readily available are valued at fair value as determined in
good faith by or under the direction of the Trust's board of trustees. All
investments quoted in foreign currency are valued daily in U.S. dollars on the
basis of the foreign currency exchange rate prevailing at the time such
valuation is determined by the Fund's custodian.
Foreign currency exchange rates are generally determined prior to the close
of trading on the NYSE. Occasionally events affecting the value of foreign
investments and such exchange rates occur between the time at which they are
determined and the close of regular trading on the NYSE, which events will not
be reflected in a computation of the Fund's net asset value on that day. If
events materially affecting the value of such investments or currency exchange
rates occur during such time period, the investments will be valued at their
fair value as determined in good faith by or under the direction of the Trust's
board of trustees. The foreign currency exchange transactions of the Fund
conducted on a spot (that is, cash) basis are valued at the spot rate for
purchasing or selling currency prevailing on the foreign exchange market. This
rate under normal market conditions differs from the prevailing exchange rate in
an amount generally less than one-tenth of one percent due to the costs of
converting from one currency to another.
PERFORMANCE INFORMATION
The Fund's performance data quoted in advertising and other promotional
materials ('Performance Advertisements') represents past performance and are not
intended to indicate future performance. The investment return and principal
value of an investment will fluctuate so that an investor's shares, when
redeemed, may be worth more or less than their original cost.
TOTAL RETURN CALCULATIONS. Average annual total return quotes
('Standardized Return') used in the Fund's Performance Advertisements are
calculated according to the following formula:
<TABLE>
<S> <C>
P(1 + T)n = ERV
where: P = a hypothetical initial payment of $1,000 to purchase shares of a specified Class
T = average annual total return of shares of that Class
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment at the beginning of that period.
</TABLE>
Under the foregoing formula, the time periods used in Performance
Advertisements will be based on rolling calendar quarters, updated to the last
day of the most recent quarter prior to submission of the advertisement for
publication. Total return, or 'T' in the formula above, is computed by finding
the average annual change in the value of an initial $1,000 investment over the
period. In calculating the ending redeemable value, for Class A shares, the
maximum 4.0% sales charge is deducted from the initial $1,000 payment and, for
Class B and Class C shares, the applicable contingent deferred sales charge
imposed on a redemption of Class B or Class C shares held for the period is
deducted. All dividends and other distributions are assumed to have been
reinvested at net asset value.
37
<PAGE>
The Fund also may refer in Performance Advertisements to total return
performance data that are not calculated according to the formula set forth
above ('Non-Standardized Return'). The Fund calculates Non-Standardized Return
for specified periods of time by assuming an investment of $1,000 in Fund shares
and assuming the reinvestment of all dividends and other distributions. The rate
of return is determined by subtracting the initial value of the investment from
the ending value and by dividing the remainder by the initial value. Neither
initial nor contingent deferred sales charges are taken into account in
calculating Non-Standardized Return; the inclusion of those charges would reduce
the return.
Both Standardized Return and Non-Standardized Return for Class B shares for
periods of over six years will reflect conversion of the Class B shares to Class
A shares at the end of the sixth year.
The following table shows performance information for the Class A, Class B
and Class C (formerly Class D) shares of the Fund for the period indicated. All
returns for periods of more than one year are expressed as an average annual
return:
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C
------- ------- -------
<S> <C> <C> <C>
Fiscal year ended January 31, 1996:
Standardized Return*................................................... 10.64% 9.37% 13.88%
Non-Standardized Return................................................ 15.27 14.37 14.63
Inception** to January 31, 1996:
Standardized Return*................................................... 1.11 0.49 2.71
Non-Standardized Return................................................ 3.23 2.48 2.71
</TABLE>
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* All Standardized Return figures for Class A shares reflects deduction of the
current maximum sales charge of 4.0%. All Standardized Return figures for
Class B and Class C shares reflect deduction of the applicable contingent
deferred sales charges imposed on a redemption of shares held for the period.
** The inception date for Class A, Class B and Class C shares is February 7,
1994.
YIELD. Yields used in the Fund's Performance Advertisements are calculated
by dividing the Fund's interest income attributable to a Class of shares for a
30-day period ('Period'), net of expenses attributable to such Class, by the
average number of shares of such Class entitled to receive dividends during the
Period and expressing the result as an annualized percentage (assuming
semiannual compounding) of the maximum offering price per share (in the case of
Class A shares) or the net asset value per share (in the case of Class B and
Class C shares) at the end of the Period. Yield quotations are calculated
according to the following formula:
<TABLE>
<S> <C>
6
YIELD = 2[ (a-b + 1) - 1 ]
---
cd
where: a = interest earned during the Period attributable to a Class of shares
b = expenses accrued for the Period attributable to a Class of shares (net of reimbursements) the average
daily number of shares of a Class outstanding during the Period that were
c = entitled to receive dividends
the maximum offering price per share (in the case of Class A shares) or the net asset value
d = per share (in the case of Class B and Class C shares) on the last day of the Period.
</TABLE>
Except as noted below, in determining interest income earned during the
Period (variable 'a' in the above formula), the Fund calculates interest earned
on each debt obligation held by it during the Period by (1) computing the
obligation's yield to maturity, based on the market value of the obligation
(including actual accrued interest) on the last business day of the Period or,
if the obligation was purchased during the Period, the purchase price plus
accrued interest and (2) dividing the yield to maturity by 360, and multiplying
the resulting quotient by the market value of the obligation (including actual
accrued interest) to determine the interest income on the obligation for each
day of the period that the obligation is in the portfolio. Once interest earned
is calculated in this fashion for each debt
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obligation held by the Fund, interest earned during the Period is then
determined by totalling the interest earned on all debt obligations. For
purposes of these calculations, the maturity of an obligation with one or more
call provisions is assumed to be the next date on which the obligation
reasonably can be expected to be called or, if none, the maturity date. With
respect to Class A shares, in calculating the maximum offering price per share
at the end of the Period (variable 'd' in the above formula) the Fund's current
maximum 4% initial sales charge on Class A shares is included. For the 30-day
period ended January 31, 1996, the yields for its Class A shares, Class B shares
and Class C shares were 7.07%, 6.62% and 6.87%, respectively.
OTHER INFORMATION. In Performance Advertisements, the Fund may compare its
Standardized Return and/or its Non-Standardized Return with data published by
Lipper Analytical Services, Inc. ('Lipper'), CDA Investment Technologies, Inc.
('CDA'), Wiesenberger Investment Companies Service ('Wiesenberger'), Investment
Company Data, Inc. ('ICD') or Morningstar Mutual funds ('Morningstar'), with the
performance of recognized stock and other indices, including (but not limited
to) the Standard & Poor's 500 Composite Stock Price Index, the Dow Jones
Industrial Average, the Russell 2000 Index, the Wilshire 5000 Index, the Lehman
Aggregate Bond Index, the Salomon Brothers High Yield Index, the Salomon
Brothers World Government Bond Index, the Merrill Lynch High Yield Index,
30-year and 10-year U.S. Treasury bonds, the Morgan Stanley Capital
International World Index and changes in the Consumer Price Index as published
by the U.S. Department of Commerce. The Fund also may refer in such materials to
mutual fund performance rankings and other data, such as comparative asset,
expense and fee levels, published by Lipper, CDA, Wiesenberger, ICD or
Morningstar. Performance Advertisements also may refer to discussions of the
Fund and comparative mutual fund data and ratings reported in independent
periodicals, including (but not limited to) The Wall Street Journal, Money
Magazine, Forbes, Business Week, Financial World, Barron's, Fortune, The New
York Times, The Chicago Tribune, The Washington Post and The Kiplinger Letters.
Comparisons in Performance Advertisements may be in graphic form.
The Fund may include discussions or illustrations of the effects of
compounding in Performance Advertisements. 'Compounding' refers to the fact
that, if dividends or other distributions on a Fund investment are reinvested by
being paid in additional Fund shares, any future income or capital appreciation
of the Fund would increase the value, not only of the original Fund investment,
but also of the additional Fund shares received through reinvestment. As a
result, the value of the Fund investment would increase more quickly than if
dividends or other distributions had been paid in cash.
The Fund may also compare its performance with the performance of bank
certificates of deposit ('CDs') as measured by the CDA Certificate of Deposit
Index, the Bank Rate Monitor National Index and the averages of yields of CDs of
major banks published by Banxquote (R) Money Markets. In comparing the Fund's
performance to CD performance, investors should keep in mind that bank CDs are
insured in whole or in part by an agency of the U.S. government and offer fixed
principal and fixed or variable rates of interest, and that bank CD yields may
vary depending on the financial institution offering the CD and prevailing
interest rates. Shares of the Fund are not insured or guaranteed by the U.S.
government and returns and net asset value will fluctuate. The securities held
by the Fund generally have longer maturities than most CDs and may reflect
interest rate fluctuations for longer term securities.
TAXES
In order to continue to qualify for treatment as a regulated investment
company ('RIC') under the Code, the Fund must distribute to its shareholders for
each taxable year at least 90% of its investment company taxable income
(consisting generally of net investment income, net short-term capital gain and
net gains from certain foreign currency transactions) ('Distribution
Requirement') and must meet several additional requirements. Among these
requirements are the following: (1) the Fund must derive at least 90% of its
gross income each taxable year from dividends, interest, payments with respect
to securities loans and gains from the sale or other disposition of securities
or foreign currencies, or other income (including gains from options, futures or
forward currency contracts) derived
39
<PAGE>
with respect to its business of investing in securities or those currencies
('Income Requirement'); (2) the Fund must derive less than 30% of its gross
income each taxable year from the sale or other disposition of securities, or
any of the following, that were held for less than three months-options, futures
or forward contracts (other than those on foreign currencies), or foreign
currencies (or options, futures or forward contracts thereon) that are not
directly related to the Fund's principal business of investing in securities (or
options and futures with respect to securities) ('Short-Short Limitation'); (3)
at the close of each quarter of the Fund's taxable year, at least 50% of the
value of its total assets must be represented by cash and cash items, U.S.
government securities, securities of other RICs and other securities, with these
other securities limited, in respect of any one issuer, to an amount that does
not exceed 5% of the value of the Fund's total assets and that does not
represent more than 10% of the issuer's outstanding voting securities; and (4)
at the close of each quarter of the Fund's taxable year, not more than 25% of
the value of its total assets may be invested in securities (other than U.S.
government securities or the securities of other RICs) of any one issuer.
Dividends and other distributions declared by the Fund in October, November
or December of any year and payable to shareholders of record on a date in any
of those months will be deemed to have been paid by the Fund and received by the
shareholders on December 31 of that year if the distributions are paid by the
Fund during the following January. Accordingly, those distributions will be
taxed to shareholders for the year in which that December 31 falls.
If Fund shares are sold at a loss after being held for six months or less,
the loss will be treated as long-term, instead of short-term, capital loss to
the extent of any capital gain distributions received on those shares. Investors
also should be aware that, if shares are purchased shortly before the record
date for any dividend or capital gain distribution, the investor will pay full
price for the shares and receive some portion of the price back as a taxable
distribution.
The Fund will be subject to a nondeductible 4% excise tax ('Excise Tax') to
the extent it fails to distribute by the end of any calendar year substantially
all of its ordinary income for that year and capital gain net income for the
one-year period ending on October 31 of that year, plus certain other amounts.
Interest and dividends on foreign securities received by the Fund may be
subject to income, withholding or other taxes imposed by foreign countries and
U.S. possessions that would reduce the yield on its securities. Tax conventions
between certain countries and the United States may reduce or eliminate these
foreign taxes, however, and many foreign countries do not impose taxes on
capital gains in respect of investments by foreign investors. If more than 50%
of the value of the Fund's total assets at the close of its taxable year
consists of securities of foreign corporations, it will be eligible to, and may,
file an election with the Internal Revenue Service that will enable its
shareholders, in effect, to receive the benefit of the foreign tax credit with
respect to any foreign and U.S. possessions income taxes paid by it for that
year. Pursuant to the election, the Fund would treat those taxes as dividends
paid to its shareholders and each shareholder would be required to (1) include
in gross income, and treat as paid by him, his proportionate share of those
taxes, (2) treat his share of those taxes and of any dividend paid by the Fund
that represents income from foreign or U.S. possessions sources as his own
income from those sources and (3) either deduct the taxes deemed paid by him in
computing his taxable income or, alternatively, use the foregoing information in
calculating the foreign tax credit against his federal income tax. The Fund will
report to its shareholders within 60 days after the end of each taxable year
their respective shares of the income from sources within, and taxes paid to,
foreign countries and U.S. possessions if it makes this election. Potential
investors should note, however, that the Fund expects that it normally will not
satisfy the above-referenced 50%-of-assets test and that, as a result, it
normally will be unable to make the election, with the consequence that foreign
and U.S. possessions taxes imposed on the Fund would not be deductible or
creditable by its shareholders.
The Fund may invest in the stock of 'passive foreign investment companies'
('PFICs'). A PFIC is a foreign corporation that, in general, meets either of the
following tests: (1) at least 75% of its gross income is passive or (2) an
average of at least 50% of its assets produce, or are held for the production
of, passive income. Under certain
40
<PAGE>
circumstances, the Fund will be subject to federal income tax on a portion of
any 'excess distribution' received on the stock of a PFIC or of any gain on
disposition of that stock (collectively 'PFIC income'), plus interest thereon,
even if the Fund distributes the PFIC income as a taxable dividend to its
shareholders. The balance of the PFIC income will be included in the Fund's
investment company taxable income and, accordingly, will not be taxable to it to
the extent that income is distributed to its shareholders.
If the Fund invests in a PFIC and elects to treat the PFIC as a 'qualified
electing fund,' then, in lieu of the foregoing tax and interest obligation, the
Fund will be required to include in income each year its pro rata share of the
qualified electing fund's annual ordinary earnings and net capital gain (the
excess of net long-term capital gain over net short-term capital loss)--which
the Fund likely would have to distribute to satisfy the Distribution Requirement
and avoid imposition of the Excise Tax--even if those earnings and gain are not
received by the Fund. In most instances it will be very difficult, if not
impossible, to make this election because of certain requirements thereof.
Pursuant to proposed regulations, open-end RICs, such as the Fund, would be
entitled to elect to 'mark-to-market' their stock in certain PFICs.
'Marking-to-market,' in this context, means recognizing as gain for each taxable
year the excess, as of the end of that year, of the fair market value of each
such PFIC's stock over the adjusted basis in that stock (including
mark-to-market gain for each prior year for which an election was in effect).
The Fund may acquire zero coupon or other securities issued with OID. As a
holder of such securities, the Fund would have to include in its gross income
the OID that accrues on the securities during the taxable year, even if it
receives no corresponding payment on them during the year. Similarly, the Fund
must include in its gross income securities it receives as 'interest' on
payment-in-kind securities. Because the Fund annually must distribute
substantially all of its investment company taxable income, including any
accrued OID and other non-cash income, to satisfy the Distribution Requirement
and avoid imposition of the Excise Tax, the Fund may be required in a particular
year to distribute as a dividend an amount that is greater than the total amount
of cash it actually receives. Those distributions will be made from the Fund's
cash assets or from the proceeds of sales of portfolio securities, if necessary.
The Fund may realize capital gains or losses from those sales, which would
increase or decrease its investment company taxable income and/or net capital
gain. In addition, any such gains may be realized on the disposition of
securities held for less than three months. Because of the Short-Short
Limitation, any such gains would reduce the Fund's ability to sell other
securities, or certain options, futures, forward currency contracts or foreign
currency positions held for less than three months that it might wish to sell in
the ordinary course of its portfolio management.
The use of hedging and option income strategies, such as writing (selling)
and purchasing options and futures and entering into forward currency contracts,
involves complex rules that will determine for income tax purposes the character
and timing of recognition of the gains and losses the Fund realizes in
connection therewith. Gains from the disposition of foreign currencies (except
certain gains that may be excluded by future regulations), and gains from
options, futures and forward currency contracts derived by the Fund with respect
to its business of investing in securities or foreign currencies, will qualify
as permissible income under the Income Requirement. However, income from the
disposition of options and futures contracts (other than those on foreign
currencies) will be subject to the Short-Short Limitation if they are held for
less than three months. Income from the disposition of foreign currencies, and
options, futures and forward contracts on foreign currencies also will be
subject to the Short-Short Limitation if they are held for less than three
months and are not directly related to the Fund's principal business of
investing in securities (or options and futures with respect to securities).
If the Fund satisfies certain requirements, any increase in value of a
position that is part of a 'designated hedge' will be offset by any decrease in
value (whether realized or not) of the offsetting hedging position during the
period of the hedge for purposes of determining whether the Fund satisfies the
Short-Short Limitation. Thus, only the net gain (if any) from the designated
hedge will be included in gross income for purposes of that limitation. The Fund
will consider whether it should seek to qualify for this treatment for its
hedging transactions. To the extent the Fund does
41
<PAGE>
not qualify for this treatment, it may be forced to defer the closing out of
certain options, futures, forward currency contracts and foreign currency
positions beyond the time when it otherwise would be advantageous to do so, in
order for the Fund to continue to qualify as a RIC.
OTHER INFORMATION
Prior to November 10, 1995, the Class C shares of the Fund were called
'Class D' shares. PaineWebber Securities Trust is an entity of the type commonly
known as a 'Massachusetts business trust.' Under Massachusetts law, shareholders
of the Fund could, under certain circumstances, be held personally liable for
the obligations of the Trust or the Fund. However, the Declaration of Trust
disclaims shareholder liability for acts or obligations of the Trust or the Fund
and requires that notice of such disclaimer be given in each note, bond,
contract, instrument, certificate or undertaking made or issued by the trustees
or by any officers or officer by or on behalf of the Trust or the Fund, the
trustees or any of them in connection with the Trust. The Declaration of Trust
provides for indemnification from the Fund's property for all losses and
expenses of any shareholder held personally liable for the obligations of the
Fund. Thus, the risk of a shareholder's incurring financial loss on account of
shareholder liability is limited to circumstances in which the Fund itself would
be unable to meet its obligations, a possibility that Mitchell Hutchins believes
is remote and not material. Upon payment of any liability incurred by a
shareholder solely by reason of being or having been a shareholder, the
shareholder paying such liability will be entitled to reimbursement from the
general assets of the Fund. The trustees intend to conduct the operations of the
Fund in such a way as to avoid, as far as possible, ultimate liability of the
shareholders for liabilities of the Fund.
CLASS-SPECIFIC EXPENSES. The Fund may determine to allocate certain of its
expenses (in addition to distribution fees) to the specific Classes of the
Fund's shares to which those expenses are attributable. For example, Class B
shares of the Fund bear higher transfer agency fees per shareholder account than
those borne by Class A or Class C shares. The higher fee is imposed due to the
higher costs incurred by the Transfer Agent in tracking shares subject to a
contingent deferred sales charge because, upon redemption, the duration of the
shareholder's investment must be determined in order to determine the applicable
charge. Moreover, the tracking and calculations required by the automatic
conversion feature of the Class B shares will cause the Transfer Agent to incur
additional costs. Although the transfer agency fee will differ on a per account
basis as stated above, the specific extent to which the transfer agency fees
will differ between the Classes as a percentage of net assets is not certain
because the fee as a percentage of net assets will be affected by the number of
shareholder accounts in each Class and the relative amounts of net assets in
each Class.
COUNSEL. The law firm of Kirkpatrick & Lockhart LLP, 1800 Massachusetts
Avenue, N.W., Washington, D.C., 20036-1800, counsel to the Trust, has passed
upon the legality of the shares offered by the Prospectus. Kirkpatrick &
Lockhart LLP also acts as counsel to PaineWebber and Mitchell Hutchins in
connection with other matters.
INDEPENDENT ACCOUNTANTS. Price Waterhouse LLP, 1177 Avenue of the
Americas, New York, NY 10036, serves as independent accountants for the Fund.
FINANCIAL STATEMENTS
The Fund's Annual Report to Shareholders for the fiscal year ended January
31, 1996 is a separate document supplied with this Statement of Additional
Information and the financial statements, accompanying notes and report of
independent accountants appearing therein are incorporated herein by this
reference.
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No person has been authorized to give any information or to make any
representations not contained in the Prospectus or in this Statement of
Additional Information in connection with the offering made by the Prospectus
and, if given or made, such information or representations must not be relied
upon as having been authorized by the Fund or its distributor. The Prospectus
and this Statement of Additional Information do not constitute an offering by
the Fund or by the distributor in any jurisdiction in which such offering may
not lawfully be made.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Investment Policies and Restrictions............ 1
Hedging and Related Income Strategies........... 11
Trustees and Officers........................... 20
Investment Advisory and Distribution
Arrangements.................................. 26
Portfolio Transactions.......................... 31
Reduced Sales Charges, Additional Exchange and
Redemption Information and Other Services..... 32
Conversion of Class B Shares.................... 36
Valuation of Shares............................. 37
Performance Information......................... 37
Taxes........................................... 39
Other Information............................... 42
Financial Statements............................ 42
</TABLE>
(Copyright) 1996 PaineWebber Incorporated
PaineWebber
Strategic
Income Fund
------------------------------------------------------
Statement of Additional Information
June 3, 1996
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PaineWebber
